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4. Aloha Bank starts with $200 in Bank Capital. It then accepts $800 in deposits. It keeps 12.5% of deposits as Reserves. It uses the rest of its assets to make bank loans. (12 marks) A. Show the Balance Sheet of Aloha Bank. (3 marks) B. What is Aloha Banks’s leverage ratio? (3 marks) C. Suppose that 10% of the borrowers from Aloha Bank default and these loans became worthless, show the Bank’s new balance sheet. (3 marks) D. By what percentage do the Bank’s total asset decline and by what percentage does the Bank’s capital decline? (3 marks)

Answer

Aloha Bank starts with $200 in Bank Capital and accepts $800 in deposits. 12.5% of deposits is kept as Reserves and the rest is used to make bank loans. This question consists of four parts: A) Show the Balance Sheet of Aloha Bank, B) Calculate Aloha Banks’s leverage ratio, C) Show the Bank’s new balance sheet if 10% of the borrowers default, and D) Calculate the percentage of Bank’s total asset and Bank’s capital decline.

A. Show the Balance Sheet of Aloha Bank

The Balance Sheet of Aloha Bank will consist of Assets, Liabilities, and Capital. The Assets will include $800 in deposits and $640 in loans, while the Liabilities will include $800 in deposits and $200 in Bank Capital.

B. What is Aloha Banks’s leverage ratio?

The leverage ratio for Aloha Bank is calculated by dividing the total assets by the total equity. In this case, the total assets are the sum of deposits and loans, which is $1440. The total equity is the Bank Capital, which is $200. Thus the leverage ratio for Aloha Bank is 7.2:1.

C. Suppose that 10% of the borrowers from Aloha Bank default and these loans became worthless, show the Bank’s new balance sheet.

If 10% of the borrowers from Aloha Bank default, the Bank’s new balance sheet will include Assets of $800 in deposits and $576 in loans, while the Liabilities will include $800 in deposits and $200 in Bank Capital.

D. By what percentage do the Bank’s total asset decline and by what percentage does the Bank’s capital decline?

Since 10% of the borrowers from Aloha Bank default, the Bank’s total assets decline by 20% (from $1440 to $1176). The Bank’s capital also declines by 20% (from $200 to $160).

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