Question

Assets:  $200 Reserves; $5000 Short term Bonds; $6000 Long Term Loans

Liabilities: $7000 Checkable Deposits; $3000 Fixed Rate Borrowings; $1200 Capital

What is the equity multiplier for this bank? Why would a bank want to increase its EM? Why would a bank decrease its EM?

Answer 1

Total Assets = TA

Capital = C

Equity multiplier (EM) = TA / C

                                    = (200 + 5,000 + 6,000) / 1,200

                                    = 11,200 / 1,200

                                          = 9.33 (Answer)

Why bank want:

Bank wants higher EM because it gives larger protection on bank ownership. Higher EM indicates more debt and less equity for the leverage of profit. Since equity is not issued further, the existing equity-holders (owners) are protected.

Why making a decrease:

This is required because of attracting deposits. People want their money to be kept as deposit in a bank that gives higher amount of security; this is possible if debt (liabilities) of the bank is low, means lower EM.