Money and Banking CM17 Homework #1 If a bank doubles the amount of its capital,

Question

Money and Banking CM17 Homework #1 If a bank doubles the amount of its capital, and ROA stays constant, then what will happen to ROE? #2 A bank has $221 million in assets, $17 million in equity capital, and $1.457 million of net profit after taxes. Calculate the equity multiplier. #3 Suppose you own a bank with no excess reserves, and a good client walks in with a request for a loan. What are your options? #4 What can a bank do to increase its ROE? #5 Delta Savings & Loan has an equity multiplier of4.7, and First Branch Trust Bank has an equity multiplier of 4.4; which institution has a higher return on equity, ceteris paribus?

Explanation / Answer

1) ROE = Net Income / Equity Capital

ROA = Net Income/ Average Total Assets

Equity Multiplier = Average Total Assets / Equity Capital

Now if ROA remains constant and capital doubles, Equity multiplier halves meaning shareholders receive half as much returns which means ROE also reduces to half its value.

2) Equity Multiplier = Average Total Assets / Equity Capital

=$221/$17 = 13

3) In such a case, bank can borrow from deposits or sell securities or take loan from the Fed or call in loans to meet customer's requirement.

4)Banks can increase their ROE by increasing their leverage. But with increased leverage, the risk also increases. ROE can also be increased by acquiring quality customers and also by improving human capital productivity.

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