Question

ASSETS	LIABILITIES
CASH 10	DEPOSITS 30
LOANS 40	EQUITY 20

A bank with the balance sheet above is met with a sudden drop in deposits of $20 due to financial problems. The bank can sell a portion of their loan portfolio for $0.50 on the dollar. The bank earns 8% on their loans, and pays 4% on their deposits. The bank can borrow money at 6%.

2. What does the bank’s balance sheet look like if it addresses the drop in deposits using stored liquidity? (3)

3. What does the bank’s balance sheet look like if it addresses the drop in deposits using purchased liquidity? (3)

4. Which method impacts income less (which method produces a smaller drop in income)? (3)

Answer 1

ANS.2: the bank’s balance sheet look like if it addresses the drop in deposits using stored liquidity.

ASSETS	LIABILITIES
CASH	20	DEPOSITS	20
LOANS	20	EQUITY	20
	40		40

ANS.3:  bank’s balance sheet look like if it addresses the drop in deposits using purchased liquidity

ASSETS	LIABILITIES
CASH	10	DEPOSITS	20
LOANS	40	EQUITY	20
		LOAN AVAILED	10
	50		50

ANS.4: if it addresses the drop in deposits using purchased liquidity, it will impacts income less (produces a smaller drop in income)

	Loan	Deposit	4% Interest given on deposit	8% Interest earned on Loan	6% Interest paid on loan	Net Income
Using store liquidity	20	20	0.8	1.6		0.8
Using purchase liquity	40	20	0.8	3.2	0.6	1.8