Question

. Washington National Bank has the following balance sheet:

Washington National Bank
Assets	Liabilities
Reserves                                $50 million	Checkable deposits $365 Million
US Treasury Securities      $75 million Loans    Residential mortgages   $100 million    Commercial                      $150 million	Bank Capital (Tier 1)   $10 Million

Calculate the bank’s risk-weighted capital. Assume that assets are risk-weighted as follows: 0% for US Treasury securities, 50% for residential mortgages and 100% for commercial loans. Describe some actions Washington National Bank can pursue to obtain a “well capitalized” risk-weighted ratio of 6.5%?

5. Why is the Federal Reserve described as an “independent” government agency? Describe some of the features of its independence and discuss the advantages and disadvantages of the independence of the Fed?

6. Explain the goals and the risks associated with a central bank’s decision to place negative interest rates on bank excess reserves.

7. Explain the purpose of reserves on deposits and specified ratios of bank capital. Discuss whether required reserves on deposits are necessary or useful for a healthy banking sector and the economy as a whole. Identify reasons why and why not.

Answer 1

Asset side

Asset	Amount($ million)	Risk-weight	Amount*Risk-weight($ million)
Reserves	50	0%	0
US Treasury securities	75	0%	0
Residential mortgages	100	50%	50
Commercial	150	100%	150

Total risk-weighted assets = 0+0+50+150 = 200

Tier-1 capital = 10

CET1 (common equity tier-1) ratio = 10/200 = 5%

To obtain a ratio of 6.5%, the bank will either have to infuse in more equity into the bank through its shareholders or decrease the asset size of commercial loans (100% risk-weight) to residential mortgages or treasury securities in order to reduce the total risk-weighted assets & increase the CET1 ratio

q2) Independence of the US Fed

Advantages: An independent US Fed can set a monetary policy that is able to achieve its target inflation rate without being influenced by the government in the central or the political system. In the recent events, President Trump had been criticizing the US Fed for keeping the benchmarks rates constant and not reducing them. Such political interference might not be beneficial to the country as a whole

Disadvantages: Strict policy implementation by the Fed by increasing the capital and the reserve ratios might not augur well for the growth rate of the country as a whole creating tension between the central party and the Fed

q3) The goal to put negative interest rates on bank excess reserves is to ensure that banks do not stack cash on their asset side and rather use that cash to pass loans. This will increase liquidity in the economy and increase the GDP. By earning negative interest on the excess cash banks hold, the NIM (net interest margin) of banks will become negative impacting their P&L

q4) The purpose of reserves is that banks maintain enough cash to cater to the withdrawal requests of the depositors based on an estimate of how much proportion of the deposit can be requested to be withdrawn at any time. Its advantage is that it infuses confidence in customers of the safety of their money in the banking system. Its disadvantage is that a very low to zero interest rate is earned on reserves. This puts pressure on the NIM and raises interest rates of other products like mortgages and corporate loans