Final answer:
The statement is true; banks can go bankrupt if there’s a high number of loan defaults because this impacts their net worth and the balance between their assets and liabilities. Banks use strategies like selling loans in the secondary market to mitigate risks, but during long recessions, even those may not suffice.
Step-by-step explanation:
A bank can indeed go bankrupt if a higher than usual number of loans are not repaid; this statement is true. When customers fail to repay loans, especially during an economic downturn, a bank's net worth can rapidly decline. Banks operate by taking in deposits and lending out funds. Deposits are the bank's liabilities, and loans are the bank's assets. If a significant number of loans default, the bank loses on assets it counted on being repaid over time.
This situation is exacerbated by the asset-liability time mismatch, wherein customers might choose to withdraw their deposits - the bank's liabilities - far quicker than the bank's assets - like loans and bonds - can be repaid. Loan defaults elevated beyond normal levels directly impact a bank's financial health and can lead to insufficient capital to cover the bank's liabilities, ultimately risking bankruptcy.
Banks adopt multiple strategies to mitigate the risks associated with loan defaults. One method is selling off loans in the secondary loan market and holding more stable assets such as government bonds or reserves. Regardless, in prolonged recessions, these strategies may not be enough to prevent a decline in net worth if a large number of loan defaults occurs.