Question

Assets:  $200 Reserves; $5000 Short term Bonds; $6000 Long Term Loans

Liabilities: $7000 Checkable Deposits; $3000 Fixed Rate Borrowings; $1200 Capital

What is the maximum amount of write-offs the bank could sustain without becoming insolvent? How do you know? If a bank becomes insolvent what are the two methods the FDIC can use to resolve the problem?

Answer 1

A) maximum amount of write-offs = Net Assets of company (Capital) = $1,000 (Capital 1,200 - Negetive Reserves 200)

B) Reason :- Insolvency Occurs when company is unable to meet its outside obligation. In current scenario, outside obligation comprise of $7000 Checkable Deposits and  $3000 Fixed Rate Borrowings. Total Assets comprise of $5000 Short term Bonds; $6000 Long Term Loans. So, there is excess of $1,000 only.

C) Two Methods :-

1. Purchase & Assumption method :- In this deposits are taken over by another bank. Aother Bank also buys few/all of the bank failed loans.

2. The assets of the failed bank are put up for sale and open banks can submit bids to purchase different parts of the failed bank's portfolio.