The government of Utah gives you permission to open your state bank named “Your

Question

The government of Utah gives you permission to open your state bank named “Your State Bank of Utah” (YSBU). After obtaining the charter from the state, you find investors that bring $1,000 in specie to form the capital of the bank (don’t forget the corresponding note on the “asset side” too)

1. After evaluating loan requests from clients, YSBU issues $1,500 in bank notes to costumers for loans payable in 1 year with a simple 5% interest rate per year over the amount lent. What is the total value of YSBU’s assets (do not take expected profits into account when computing assets’ value)? What is the total value of YSBU’s liabilities?

2. What is YSBU’s reserve ratio (remember that the “reserves” part in computing the reserve ration refers to the total amount of specie that the bank has)? What is YSBU’s money multiplier? Is YSBU a “partial reserve system” (a.k.a. “fractional reserve”) type of bank? Why or why not? What is YSBU’s expected profit if everything goes well and the principal of the loan and the interests are paid at the end of the year?

3. Is YSBU in danger of having a liquidity crisis? Why or why not? What is the maximum loss in the value of assets that YSBU can suffer without incurring into an insolvency crisis?

4. After passing the National Banking Act in 1763 the Federal Government creates a 10% tax on the total value of issued by the state banks. Therefore, ignoring other costs for simplicity, total profits of state banks will be given by interests collected on loans minus taxes paid on notes issued. What are the expected profits of YSBU after the Federal Government creates the tax on notes (again, assume that all the loans are fully repaid with 5% interest)?  

Explanation / Answer

Ans1. Assuming a part of the loan comes back to the bank as deposits. The YSBU will have loans advanced of $1500 as assets and Deposit of $500 as laibilities and $1000 as capital.

2. Reserve ratio for YSBU is the ratio of capital that is kept to secure the deposits which is

Reserve ratio= Cash/ Deopsits= 0/500=0

Money multiplier= Loans advanced/ deposits = 1500/500=3

Yea. YSBU does follows a "partial reserve system" since all the deposits are backed by no cash. If everything goes well then YSBU will earn a profit of $75 in a year.If deposits were free of interest.

3. Yes. YSBU is in a liquidity crisis since all it's cash is used up to provide loans. YSBU can incurr a loss of $1000 which is with the public in the form of cash.

4. $7.5 will be paid as taxes which is 10% of $75. The expected profits will drop to $68.5.

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