4 Consider a commercial bank with the following balance sheet: Cash $7m Deposits

Question

4

Consider a commercial bank with the following balance sheet:

Cash                $7m                 Deposits          $74m

Gross Loans    73m                Equity                 6m

Suppose the managers of the bank believe that $4 million of its loan portfolio is likely to be unpaid based on macroeconomic conditions. Which of the following is most accurate concerning how the financial institutions balance sheet will change?

Select one:

a. The loan losses will be added to loans in the amount of $4 million

b. Equity drops to $2 million, causing potential equity capitalization issues

c. The loan losses are paid out of cash and there is no change to bank equity

d. The loan losses will be added to loans in the amount of $4 million & Equity drops to $2 million, causing potential equity capitalization issues

Explanation / Answer

d. The loan losses will be added to loans in the amount of $4 million & Equity drops to $2 million, causing potential equity capitalization issues

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