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____the_____account. This would also bring the leverage ratio from its initial value of to a new value of_____. Which of the following is true of the capital requirement?A. It specifies a minimum leverage ratio for all banks. B. Its intended goal is to protect the interests of those who hold equity in the bank. C. Its intended goal is to protect the interests of the depositors.

Answer 1

1. This would increase the reserves account and increase the debt account.

The bank borrowed $100 to supplement their reserves which increased the reserves account. It will also increase the debt account to reflect the liability.

2. This would also bring the leverage ratio from its initial value of 14 to a new value of 14.8.

Leverage is calculated as;

Original leverage = Total assets/ Capital

= ( 175 + 875 + 700)/125

= 14

New Leverage = ( 175 + 875 + 700+ 100 increase in reserves)/125

= 14.8

3. C. Its intended goal is to protect the interests of the depositors.

Capital is held by banks as a safeguard against people defaulting on loans because loans are derived from the money deposited by depositors and will need to be paid back to them. If a loan is defaulted on therefore, the bank pays the depositor from the capital it holds.