A bank has the following assets: Required Reserves of $5 million; Loans of $150

Question

A bank has the following assets: Required Reserves of $5 million; Loans of $150 million; Securities of $50 million. The bank's liabilites are: Deposits of $140 million, Borrowed funds from the Fed of $35 million and Bank Capital of $30 million. Suppose there is a deposit outflow of $5 million. To cover the outflow the bank must find a way to get $5 million in cash. Look at the four possible ways of getting that cash to cover the outflow and answer every question separately:

a) the bank calls-in some of the loans - state the cost the bank will incure by doing so

b) the bank sells some of its securities - state the cost the bank incures with this action

c) the bank borrows from another commercial bank - state the cost the bank incures with this action

d) the bank borrows from the Fed - state the cost the bank incures with this action

Explanation / Answer

a) the bank calls-in some of the loans - state the cost the bank will incure by doing so : The bank will have to forego the interest income from loans.

b) the bank sells some of its securities - state the cost the bank incures with this action : The bank loses interest income due to premature sale of securities.In addition to lower interest , there may be some preclosure charges.

c) the bank borrows from another commercial bank - state the cost the bank incures with this action : The bank pays the inter-bank call money interest.

d) the bank borrows from the Fed - state the cost the bank incures with this action: The bank pays the interest as per the Federal Bank rates.

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