Bank Runs and FDIC Consider a mutual savings bank (depositors are the owners of

Question

Bank Runs and FDIC

Consider a mutual savings bank (depositors are the owners of the bank) with 1000 depositors. In the beginning of a year, each depositor makes $100,000 deposit. The bank holds 10% of the total deposit in vault cash. The remaining deposit is invested in a project with a 10% rate of return at the end of the year. However, if the bank liquidates it investment, it only gets 50% of its initial investment back. For simplicity, we assume that this mutual saving bank does not have to comply to any reserve requirement.

a) Suppose the bank does not have to liquidate its investment project, what is the return after a year on each deposit account?

b) Suppose 10 depositors decide to withdraw all their deposit after a month. What is the return after a year on each remaining deposit account?

c) Suppose every depositor thinks that more than 20% of depositors will withdraw after a month, what should a depositor do? What is the return on each deposit account in this case?

d) Now the bank becomes a member of FDIC, which guarantees that any deposit account up to $250,000. Answer the question in c.

Explanation / Answer

a. Return of the depositor if no one withdraws cash

part- B: If 10 depositors withdraw the money, then this can be funded from the cash vault and the investment need not be liquidated.

Part -C

If all depositors think that 20% of the deopsitor will withdraw the cash, the the investment of the bank has to liquidated and all deposits will be be at a loss.

Hence the depositor should not consider depositing the money in "Mutual Savings Bank"

The return is calculated as follows:

Hence the customer will be at a loss of 45%

Part D:

If there is an Insurance from FDIC of $250,000 for each customer, The customer can now deposit the money in the bank since it is guranteed by the FDIC

Number of depositors 1000 Deposit of each depositor 100000 Total Deposit 100000000 Cash at Vault 10000000 Available for Investment 90000000 Avaibale after an year with 10% return 99000000 Total Available after an year 109000000 Avaialble for each depositor 109000 Total Return 9.00%

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