Question

(1.)

(a.) Suppose that a bank’s total assets are comprised of $85 million of reserves and $125 million of loans and its total liabilities are $140 million in deposits. If the bank’s return-on-assets (ROA) is 1.00%, determine its return-on-equity (ROE).

(b.) In your own words, explain the bene?ts and costs for a bank when it decides to increase the amount of its capital.

Answer 1

(a)Total Assets = Reserves +loans = 85 +125 = 210 million

Since the ROA is 1%, the net income of the bank = 210 Million *0.01 = 2.1 Million

Equity = Assets - Liabilities = 210 -140 = 70 Million

Return on Equity (ROE) = 2.1/70 = 0.03 = 3%

(b) Benefits are:

1. Increased money supply available for loans which the bank can get a higher interest rate. So, the bank can expect higher net interest income

2. The size if the bank grows and as the size grows, the bank can expand its geographical footprint and get more customers

Costs

1. Higher reserves with the central bank which give no income or just inflation adjusted income to the bank

2. Shareholder's equity may get diluted due to raising more capital.