Question

Based on the balance sheet below, answer the following questions.

Capital Requirements for Melvin’s Bank
	Assets	Weights	Weighted Assets
Reserves	20	0.0
Securities
Treasury Bonds	45	0.0
Municipal Bonds	10	0.5
Loans
Interbank	25	0.2
Home Mortgages	20	0.5
C & I	80	1.0
Total	200

a) Based on the balance statement above, calculate the level of capital that Melvin's must hold to satisfy the minimum equity ratio (5%)

b) Based on the balance statement above, calculate the level of capital that Melvin's must hold to satisfy the risk based Basel requirement (8%)

c) which of the two requirement is more stringent in this case? If so, why?  

Answer 1

a) Equity ratio is the ratio of total shareholders equity to total assets of the firm.It is expressed in terms of percentage.

Equity ratio = Total shareholder's equity/total asset.

In the question,

Total asset = Reserves + Treasury Bonds + Municipal Bonds + Interbank + Home Mortgages + C&I

Total Asset = 20+45+10+25+20+80 = 200

The Minimum equity ratio is 0.05

Therefore, according to the formula mentioned above,

0.05 = Equity/200

equity = 0.05*200=10

Thus minimum equity is 10.

b) According to the risk based Basel requirements, firms have to maintain a minimum capital adequacy ratio of 8%. Capital adequacy ratio is the capital to risk weighted assets ratio.

Thus according to the question, the risk weighted asset = 0*20+0*45+0.5*10+0.2*25+0.5*20+1*80

therefore, risk weighted asset = 5+5+10+80=100

Capital adequacy ratio = 0.08 = equity/100

therefore equity = 8

c) In the given question, the minimum equity ratio is more stringent as it requires the firm to keep a higher amount of capital. This can be because the firms assets are not very risky and thus the amount of minimum capital required in b) part is lower.