Question

Use the information presented in Midwestern Mutual Bank's balance sheet to answer the following questions. Bank’s Balance SheetAssets Liabilities and Owners' EquityReserves $150 Deposits $1,200Loans $600 Debt $200Securities $750 Capital (owners' equity) $100Suppose a new customer adds $100 to his account at Midwestern Mutual Bank, which the owners of the bank then use to make $100 worth of new loans. This would increase the loans account and (increase/decrease) the (debt,capital,deposits,loan, reverse) 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? Check all that apply.Its intended goal is to protect the interests of those who hold equity in the bank.The amount of capital required depends on the type of assets the bank holds.It specifies a minimum leverage ratio for all banks.

Answer 1

Answer:

Midwestern Mutual Bank's Balance Sheet

Equity:

Owners' Equity - $100

Liabilities:

Deposits $1,200

Debts $200

Total - $1,400

Equity and Liabilities = $1,500

Assets:

Reserves - $150

Loans $600

Securities $750

Total Assets - $1,500

a) If a new customer adds $100 to his account, this would increase the loans account with $100 and the deposits account with $100.

b) The leverage ratio is the measure of the bank's core capital to total assets.

Old leverage ratio = 100 / 1500 x 100% = 6.67%

The new leverage ratio is 100 / 1600 x 100% = 6.25%.

c) The intended goal of capital requirement is protect the interests of those who hold equity in the bank.

Explanation:

Banks are highly leveraged.  This means that they usually maintain high leverage ratios.  The liabilities are always much compared to the capital.

Leverage ratio is the ratio of a bank's core capital (shareholders equity) to its total assets.

This is why the Federal Reserve introduces capital requirements for banks.  This tries to protect shareholders' equity that is usually written down when leverage ratios increase.  This is because the capital portion of assets to which the debts are tied can be written down, but the debts cannot.