CASH 10 DEPOSITS 30
LOANS 40 EQUITY 20
A bank with the balance sheet above is met with a sudden drop in deposits of $20 due to financial problems. The bank can sell a portion of their loan portfolio for $0.50 on the dollar. The bank earns 8% on their loans, and pays 4% on their deposits. The bank can borrow money at 6%.
2. What does the bank’s balance sheet look like if it addresses the drop in deposits using stored liquidity?
3. What does the bank’s balance sheet look like if it addresses the drop in deposits using purchased liquidity?
4. Which method impacts income less (which method produces a smaller drop in income)?
2. They would need to use the $10 in cash and have to sell $20 loan at $10. This would result in liabilities being in excess of assets and lead to loss in equity value
3. They would need to borrow at 6%
4. The return from internal funding - 1.6 from Loans - 0.4 from deposits = 1.2
Return from external funding = 3.2 from loans - 0.4 from deposits - 1.2 from borrowings = 1.6
External funding would be the better option
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