Question

1.In order to increase the capital/asset ratio, a bank can do all of the below EXCEPT:

Question options:

	Reduce the amount of loans and add these funds to reserves.
	Reduce the amount of loans and use the funds to pay back loans.
	Issue new equity.

2.Banks are reluctant to hold a lot of bank capital because:

Question options:

	the bank capital can not be used for lending.
	a higher capital/asset ratio leads to higher return on equity.
	a higher capital/asset ratio leads to lower return on equity

3.Banks can manage their credit risk in a number of ways listed below. The only action below that is NOT an example of how to manage credit risk is:

Question options:

	screening borrowers.
	specialization in lending to develop expertise in certain areas they lend to.
	credit rationing, giving borrowers a smaller loan than they ask for.
	requiring high interest rates.

Answer 1

1. Reduce the amount of loans and add these funds to reserves.

In order to increase the capital/asset ratio, a bank can do all of the below EXCEPT: Reduce the amount of loans and add these funds to reserves. The bank can increase capital asset ratio by increasing its retained earnings or reserves. It can do so by reducing the amount of profit it pays out as dividends. Also, it can boost its profits by increasing the difference between interest rate that it charges on its loan & those it pays on its funding.

2. A higher capital/asset ratio leads to lower return on equity.

Banks are reluctant to hold a lot of bank capital because: a higher capital/asset ratio leads to lower return on equity. Higher bank capital will result in lower return on equity. Return on equity is calculated by net profits divided by equity capital. Therefore, when capital will be higher, return on equity will be lower.

3. Requiring high interest rates.

Banks can manage their credit risk in a number of ways listed below. The only action below that is NOT an example of how to manage credit risk is: requiring high interest rates. Except requiring higher interest rates, all the three alternatives can be used to manage credit risk. Apart from these, credit risk can be managed in several other ways like collateral makes a loan secured, loan commitments, long-term relationships with the customers, monitoring & enforcement, etc.