Trout Lake Financial has $20 million in capital and $200 million in deposits. Th
ID: 2712194 • Letter: T
Question
Trout Lake Financial has $20 million in capital and $200 million in deposits. The bank makes a $50 million commercial loan and lends another $100 million in mortgages, with the following terms: 400 standard 30- year, fixed- rate mortgages with a nominal annual rate of 4% each for $250,000. Assume that desired reserves are 8%.
a) [1 Mark] Calculate the risk-weighted assets and risk-weighted capital ratio for Trout Lake Financial.
b) [2 Marks] The next day the bank invests another $50 million in commercial loans. However, later that day, a major housing market shock forces mortgage rates up to 7.33%, which implies that the present value of Trout Lake’s mortgage holdings is now only $ 150,000 per mortgage. Bank regulators force Trout Lake to sell its mortgages to recognize the fair market value. Reconstruct Trout Lake’s balance sheet to account for this new information. How do these events affect its capital position?
c) [2 Marks] In order to avoid a bank failure, banking regulators decide to give Trout Lake a $30 million capital injection. However, once Trout Lake’s financial situation becomes known, a bank run results and $50 million in deposits is withdrawn. Reconstruct Trout Lake’s balance sheet to account for this new information. If the regulators decide that Trout Lake needs a capital ratio of 10% to prevent further bank runs , how much of an additional capital injection would be required to reach a 10% capital ratio?
Explanation / Answer
a)The risk weight assigned to loan is 100% by Basel rule and 50% for mortgage as assigned by Basel assuming the mortgage is backed by collateral as a house.
risk-weighted assets=100%*$50 million + 50%* $100 million=$50 million +$50 million =$100 million
risk-weighted capital ratio =$20 million in capital/$100 million=20%
b) Initial position of balance sheet,
Total deposit= $200 million
Total commercial loans=$100 million
Total mortgage value=$100 million
After rate rise, Total mortgage value=150,000*400=60,000000=$60 million
Total capital required=8% of $100 million=$8 million
Loss recognized from rate rise=$40 million is $12 million from capital and $28 million from deposits
Final position of balance sheet,
Total deposit= $172 million
Cash=$72 million
Total commercial loans=$100 million
The capital has reduced to 8% of $8 million
c)
Final position of balance sheet after capital infusion,
Total deposit= $200 million
Cash=$100 million
Total commercial loans=$100 million ,the capital now is 8+2=$10 million or 10%
Final position of balance sheet after bank run,
Total deposit= $122 million
Cash=$22 million
Total commercial loans=$100 million There would be no capital injection would be required to reach a 10% capital ratio as its already 10%.
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