3. Assume required reserves are 10% of deposits. A Bank (Billions of $) Assets L

Question

3. Assume required reserves are 10% of deposits. A Bank (Billions of $) Assets Liabilities 100 Reserves 1000 Deposits 900 Loans 120 BC 200 Securities 80 Borrowing If there is a sudden run on deposits of $100 billion, what problems does this cause for this bank? Show four ways this bank can deal with the problem created in question 4a. Now suppose this bank has to write off $130 billion in mortgages. What problem is the bank facing now? How will the problem in question 1c be resolved? a. b. c. d.

Explanation / Answer

Part 1

If there is sudden withdrawl of $ 100, than it will reduce the reserves to Zero whereas required will be 10% of the deposit. Consequently, bank will again have to create reserve for the 10% of $ 900 left = $ 90 to confirm with rules. However, this will degrade the liquidity position of the bank

Part 2

1. Bank can take short term borrowing from other banks at bank rate.

2. Bank can deposits securities with the central bank and take short term or long term loan against them.

3. Bank can increase the deposit rates and lure customers to deposit money

4. Bank can sale out the securities.

5. Recall loans (thereby increasing reserves and decreasing loans by the same amount without affecting deposits).

Part C

Bank has to write off the $130 billion. This is the long term capital issue as no money will be received by the banks. This will reduced the assets sides by $130 Bn.

Part D

By increasing reserves and equity amount

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