A bank’s assets consist of: Cash: $1.5 million Loans: $10 million Securities: $4

Question

A bank’s assets consist of:
                                                                                                                                                                                                      Cash: $1.5 million
Loans: $10 million
Securities: $4.5 million
Fixed assets: $2 million
In addition, the bank’s owners’ capital is $1.5 million.
                                                                                                                                                                                                   a. Calculate the equity capital ratio.
b. If $2 million in bad loans were removed from the bank’s assets, show how the equity capital ratio would change.     

Explanation / Answer

a) Equity Capital ratio= Equity/ Total Capital = 1.5/18= 8.33%

Equity= 1.5Million

Total Capital= 1.5+10+4.5+2 = 18 Million

In this case, bank liabilities are 18 - 1.5 = 16.5 Million

b) If $2 million in bad loans were removed from the bank’s assets

Revised total assets = 18-2 = 16 Million. If total liabilities remains at $16.5 Million, the bank owner’s capital is -0.5Million (16-16.5) and the equity capital ratio will be undefined. Of course the impact on owner’s capital is less if the bank had provided a loan-loss reserve

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