a.What can you bank do with its assets to reduce the risk above? List three othe
ID: 1103162 • Letter: A
Question
a.What can you bank do with its assets to reduce the risk above? List three other actions that your bank can undertake to reduce the risk above
b.How would increase in bank capital affect the risk that the bank would become insolvent? What is the cost of this strategy?
c.Suppose short-term interest rates increased by 2%. How would this affect your bank profit?
d.List one thing you bank could do on the asset side to reduce the risk associated with the increase in the short-term interest rates
e.List one thing you bank could do on the liability side to reduce the risk associated with the increase in the short-run interest rates
f.Given your bank’s balance is the upward slopping yield curve a good thing for you bank or a bad thing?
g.How would the increase in the demand for mortgage loans affect you bank cash reserves and its holdings of government securities?
Assets with current interest rate Liabilities with current interest rate | $20 million Checking deposits SavingS Deposits Reserves Fixed: 0% $5million Variable: 1% Government Variable: 2% | $10 million Fixed: 2% $25 million Securities $35 million Money Market | Variable: 3% Deposit Accounts Bank Capital Fixed: 6% | $10 million Mortgage Loans Short-Term Loans | $10 million To be determined Variable: 7% To be determined Business Loans Fixed: 9% $20 million Total Assets $80 million Total Liabilities $80 millionExplanation / Answer
a) three other actions that your bank can undertake to reduce the risk above: i) Bank can invest more money in government securities rather than be giving unsecured loans.ii) The bank should only lend higher amount loans to creditworthy businessmen with proven repayment record to reduce the risk of loan default.iii) Banks can increase mortgage loans as they are more secure.
b) Increase in bank's capital will make it financially stronger. Its capacity to lend will increase and hence its customer base will also increase. Bank can then achieve economy of scale and higher profits can be aimed with increased business potential. This will lead bank away from insolvency. However, the banks shareholding will increase and its liabilities to repay increased capital will also increase.
c) This will lead to increase in banks profit as it will get more money in return. However, a decrease in the number of borrowers can be the issue for the bank.
d) Bank can decrease mortgage loans by 0.5 basis points to 1 % to increase secure loans and its customer base to increase lending and earn profit thereby.
e) Bank can increase its capital to expand its business or can offer additional 0.2 basis points interest on savings deposits to attract more customers.
f) It is good if customers are keeping the money for a longer duration and banks total deposits will increase and its capacity to lend too will increase.
g) Bank will be left with fewer cash reserves and it will have lesser amount to invest in government securities and hence government securities with the bank will go down; but due to increase in loans backed by mortgages its business will grow and the bank will get a higher rate of return and this will ultimately increase banks profitability in the longer run.
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