Modern bank runs Suppose that a European bank has customer deposits of \(€ 500\)

million and capital of \(€ 100\) million and total assets of \(€ 600\) million, divided as loans equal to \(€ 400\) million and other assets equal to \(€ 200\) million.

a. Prepare the balance sheet of the bank.

b. Suppose that some recent problems with the bank prompt customers to withdraw \(€ 100\) million of their deposits. How can the bank preserve the same level of capital and assets on its balance sheet?

c. Prepare the new balance sheet of the bank.

d. If that the central bank does not insure customers' deposits, do you think that there will be a deposit run? How would the outcome change if the bank announces that it had recently approached a highly reputable and financially solid private insurance firm that has legally agreed to ensure customers' deposits?

e. Now suppose that it becomes known that the bank is facing serious solvency problems that do not allow it to borrow from depositors or financial institutions. What are the two options available to the bank to avoid bankruptcy?

Now consider a different sort of bank, still with assets of 100 and capital of 20, but now with short-term credit of 80 instead of checkable deposits. Short-term credit must be repaid or rolled over (borrowed again) when it comes due.

f. Set up this bank's balance sheet.

g. Again suppose the perceived value of the bank's assets falls. If lenders are nervous about the solvency of the bank, will they be willing to continue to provide short-term credit to the bank at low interest rates?
h. Assuming that the bank cannot raise additional capital, how can it raise the funds necessary to repay its debt coming due? If many banks are in this position at the same time (and if banks hold similar kinds of assets), what will likely happen to the value of the assets of these banks? How will this affect the willingness of lenders to provide short-term credit?