Question

1. Imperial Bank has deposits of $150 million and securities of $110m; the bank also makes loans to its customers
   1. Suppose the bank makes bad loans to the tune of $5m, show and explain how the balance sheet will be altered. (5 points)
   2. Explain why regulators may or may not close the bank as a result of the bad loans. (5 points)
   3. Assuming that the net profit of the bank is $100m, what is the return on equity of the bank?
   4. Using the decompositions of the ROE, discuss the contributions of the equity multiplier and assets to the return on equity (ROE);
   5. alternatively, what is driving the return on equity?

Answer 1

Answer (a)- It will be a loss for the bank which reflected in the P&L and then it will reduce the reserve & surplus amount in the balance sheet.

Answer (b)- This is the nature of the business, normally bank does the due delligence before giving the loan to the customer but still due to some reason customer is not able to pay the EMI/loans and bank has to declared these kind of loan as NPA. Hence, Regulator will not close the bank or take any action if all the proper documation/verification being done while providng the loans to customer.

Answer (c)- 40% is the retun on equity of the bank.

Answer (d): ROE can be calculate by using dupont analysis which comprise of Net Profit Margin * Equity Multiper * Asset Turnover

ROE = Net profit/Sales * Sales/Assets* Assets/Share holder equity

Answer (e): As mentioned above, Net profit margin, equity mulitplier and Asset turnover driving the return on equity.

A