Question

Assume a bank has 5,000,000 EUR in equity, 50,000,000 in loans to customers, government bonds of 50,000,000 EUR, liquidity of 10,000,000, and deposits of 105,000,000 EUR. Risk weight for government bonds is 100%. Risk weight of liquidity is 0%. Risk weight for loans is 100%. How much bank equity does the bank have to hold and how can the bank react?

Answer 1

Risk weight for government bonds =100%. , 50,000,000 EUR

Risk weight of liquidity is 0%. , 10,000,000 EUR

Risk weight for loans is 100%. , 50,000,000 EUR
Equity = 5,000,000 EUR
assuming deposits has 0% risk
Portfolio Risk for Debt= 100*50,000,000+0%*10,000,000+ 0%* 105,000,000+ 100%*50,000,000 = 100,000,000 EUR
Capital = 5,000,000
Capital Adequacy Ratio = 5,000,000/100,000,000 = 5%

Minimum Capital Adequacy required for Bank= 8%
So minimum capital or equity bank needs needs to have is = 8%* 100,000,000 = 8,000,000

1. In order to meet its financial obligation of 3,000,000 (8,000,000- 5,000,000), bank should issue securities of 3,000,000 to have total Equity of 8,000,000
2. In case it doesn't issue securities, it should call back loans.