Question

The initial T-accounts of Bank A and Bank B are as follows:

Bank A
Assets		Liabilities
Reserves	$55 mil	Deposits	$495 mil
Loans	$495 mil	Bank	$55 mil

Bank B
Assets		Liabilities
Reserves	$55 mil	Deposits	$528 mil
Loans	$495 mil	Bank	$22 mil

a. Suppose each of both banks needs to write off bad loans of $27.5 million, prepare new T-accounts for both banks. What problem is Bank B facing?

b. Given the return on assets (y%), the higher the bank capital is, the higher will be the return on equity for the owners of the bank. Do you agree? Use the information from the initial T-accounts of Bank A and Bank B to support your answer.

c. What conclusion could you draw from (a) and (b)?

Answer 1