A bank has received $250 million deposits. Its shareholders’ equity value is equal to $20 million. It holds $85 million worth of securities (e.g. government bonds). Its required reserve ratio is equal to 0.06 (or 6%). It has made a certain amount of loans and it is solvent.
a) Write down the balance sheet of the bank, assuming that the bank has made the maximum amount of loans it can. Make sure you label the columns clearly. How much in reserves does it hold? What value of loans has it made?
b) Suppose the bank’s securities holdings have lost $25 million of their value due to poor financial market performance. Draw a new balance sheet for the bank. Explain why the bank is considered to be insolvent after the loss.
c) As a result of (b), the bank is now subject to a bail-out. Define a bail-out and explain the minimum value of the bail-out that the bank must undertake. Illustrate the balance sheet of the bank after the bail-out occurs.