Question

Use the information presented in Midwestern Mutual Bank's balance sheet:

Bank's Balance Sheet
Assets Liabilities and Owners' Equity
Reserves $175 Deposits $1,400
Loans $700 Debt $225
Securities $875 Capital (owners'
equity) $125
Suppose the owners of the bank borrow $100 to supplement their existing reserves. This would increase the reserves account and (increase/decrease) the (capital/debt/deposits/loans/reserves) account. This would also bring the leverage ratio from its initial value of (14/14.8/16.1/18.2) to a new value of (14/14.8/16.1/18.2). Which of the following is true of the capital requirement?
A. The higher the percentage of assets a bank holds as loans, the higher the capital requirement.
B. It specifies a minimum leverage ratio for all banks.
C. Its intended goal is to protect the interests of those who hold equity in the bank.

Answer 1

Answer and Explanation:

In the given case it is mentioned that when the bank borrow $100 in order to supplement their existing reserves

So it would increase the reserve and debt by $100

The initial value of the leverage ratio is

= total assets ÷ total equity

= (Reserves+ loans+ securities) ÷ (owner's enquity)

= ($175 + $700 + $875) ÷ $125

= $1750 ÷ 125

= 14

Now the new value of the leverage ratio is

= total assets ÷ total equity

= (Reserves+ loans+ securities) ÷ (owner's enquity)

= ($175 + $700 + $875 + $100) ÷ $125

= $1850 ÷ $125

= 14.8

The statement that should be true for the capital requirement is option A as it derives that the greater the percentage of the asset the bank would hold the more the capital requirement