Question

Happy Bank starts with $200 in bank capital. It then takes in $1,000 in deposits. It keeps 15 percent of deposits in reserve. It uses the rest of its assets to make bank loans.

Q(1): Happy Bank (T-Account)
Assets | Liabilities
Reserves = _____. Deposits = _____.
Loans = _____. Bank Capital = _____.
Q(2): Happy Bank's leverage Ratio is ____.
Suppose that 8 percent of the borrowers from Happy Bank default, and these bank loans become worthless.
Q(3): Happy Bank's (New balance sheet)
Assets | Liabilities
Reserves = _____. Deposits = _____.
Loans = _____. Bank Capital = _____.
Q(4): The bank's total assets decline by _____, and the bank's capital declines by _____.

Answer 1

Q (1): A T-account is a form used in accounting to keep track of the debit and credit sides of transactions. The question requires us to fill in the T-account of Happy Bank, which would tell us about the bank's assets and liabilities. The T-account of Happy Bank is as follows:

• Assets: Reserves = 150Deposits = 1000 Loans = 850 Bank Capital = 200 Liabilities:

Q (2): The leverage ratio is the ratio of the bank's assets to its capital. Happy Bank's assets would be the sum of its reserves, loans, and deposits. The bank's assets would be the sum of its reserves, loans, and deposits.

Assets = Reserves + Loans + Deposits Assets = 150 + 850 + 1000 Assets = 2000Happy Bank's leverage ratio is calculated as follows:

• Leverage ratio = Assets / Bank capital

• Leverage ratio = 2000 / 200 Leverage ratio = 10

Q (3) The bank's new balance sheet would be as follows:

• Assets: Reserves = 85 Deposits = 1000 Loans = 765 Bank Capital = 150 Liabilities:

Q (4) The question states that 8% of the borrowers from Happy Bank default, and these bank loans become worthless. The bank's total loans = are $850. Therefore, 8% of loans would be:

• 8/100 × 850 = 68.

• These loans are now worthless, and the bank's total loans are reduced by $68. The bank's new loans = $850 - $68 = $782. Happy Bank's capital is unchanged from its previous balance sheet.

Therefore, the bank's capital is still $200. The bank's total assets decline by $68 (the defaulting borrower's loans). Therefore, the bank's new total assets = $2000 - $68 = $1932.The bank's capital declines by zero. Therefore, the bank's new capital =is $200. Happy Bank's new balance sheet is as follows:

• Assets: reserves = 85 Deposits = 1000 Loans = 782 Bank Capital = 200 Liabilities: