2 Capital ratio, leverage ratio and credit risk, 20 points A commercial bank's T-account in 2018 is shown as below: Table 2: T-Account for Bank A in 2018 Assets Loans: $ 900 Securities: $ 100 Cash Reserves: $60 Equity:? Liabilities plus Equity Deposits: $900 Borrowings: S0 Compared to the last question, the loans increase by S100 which are financed by the bank's equity as required by the central bank. The bank pays 10% for the bank deposit to the depos- tors, the average interest rate on the loans is 15%; and the returns to its securities is 10% (1) Calculate the value of equity, the value of capital ratio, the leverage ratio and the return on equity? (2) If S 100 of the loans is defaulted, what does the new T-Account look like? What is the new equity value? Will the bank become insolvent after the loan is defaulted? (3) The objective for the operation of a commercial bank is to maximize the return on equity with the credit risk (the possibility of a negative equity) and liquidity risk in control. Compare your answer to the current question with the answer to question (1), discuss how financing the loans with equity would affect the credit risk and the return on equity. Why the central bank usually imposes a lower bound on the capital ratio? (Remark: As of 2017, under Basel III, a bank's tier 1 and tier 2 capital must be at least 8% of its risk-weighted assets. The minimum capital adequacy ratio (including the capital conservation buffer) is 10.5%)