Question

Brenda Olivia Adams starts her own bank, called BOA. As owner, Brenda puts in $2,000 of her own money. BOA then borrows $3,000 in a long-term loan from Brenda’s roommate, accepts $5,000 in demand deposits from her neighbors, buys $1,000 of corporate bonds, lends $6,000 to local businesses to finance new investments, and keeps the remainder of the bank’s assets as reserves at the Fed.

An economic downturn causes 10 percent of the local businesses to declare bankruptcy and default on their loans. Show BOA’s new balance sheet. By what percentage does the value of BOA’s assets fall? By what percentage does BOA’s capital fall?

BOA Assets Liabilities Reserves $3000Deposits $5000 Loans $ Debt $3000 Securities $1000 Capital $ Total $ Total $ Percentage decline in value of assets = % Percentage decline in value of capital = %

Answer 1

In the above mentioned question, initially the balance sheet of the Bank will be like this:

LIABILITIES		ASSET
CAPITAL	2000	BONDS	1000
LONG TERM BORROWING	3000	LOAN TO NEW BUSINESS	6000
UNSECURED LOAN	5000	BANK'S ASSET TO RESERVE	3000

After booking loss, the Bank will show provisioning of $600 by which balance sheet will be impacted and the size of balance sheet will reduce from $10000 to $9400 and new Balance sheet will look like this:

	BALANCE SHEET
LIABILITIES		ASSET
CAPITAL	1400	BONDS	1000
LONG TERM BORROWING	3000	LOAN TO NEW BUSINESS	5400
UNSECURED LOAN	5000	BANK'S ASSET TO RESERVE	3000

The asset of the firm BOA will fall by 6% (600/10000*100=6).

The capital of the firm will reduce by 30%(600/2000*100=30)

Also, in some cases money taken by relatives or friends is also considered as capital, in such case the capital will reduce by 8.57%( 600/7000*100=8.57%)