Suppose State Bank\'s initial balance sheet is as follows: What is State Bank\'s

Question

Suppose State Bank's initial balance sheet is as follows: What is State Bank's leverage ratio? Suppose that some of State Bank's securities were bonds whose value was linked to risky subprime mortgages. When some homeowners could not pay their monthly mortgage payments, the value of these bonds fell. Suppose the value of State Bank's securities fell by $10. What is the percentage reduction in the value of its securities? What is the percentage reduction in the value of its capital? Now suppose that some of State Bank's car loans could not be repaid because the car owners lost their jobs during the recession. If the value of State Bank's loans also fell by $10, what is the value of State Bank's capital now (that is, after both falls invalue)? In order to ensure that banks can pay their depositors, bank regulators require banks to maintain a minimum ratio of bank capital to assets, called capital requirements. Suppose that State Bank's capital requirement was 8%. Did the bank meet this requirement in part c? Show your calculation.

Explanation / Answer

a.

Leverage ratio has two parts—debt ratio and debt-to-equity ratio.

Debt ratio = Total debt / Total assets

                 = $200 / ($100 + $300 + $200)

                 = $200 / $600

                 = 33.33%

Debt-to-equity ratio = Total debt / Total equity

                                 = $200 / $50

                                 = 400%

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