7. Leverage and insolvency Consider the following balance sheets of two banks. These two banks have equal amounts of assets but are leveraged differently. Assume that there is no regulatory capital requirement. Balance Sheet of Pry Bank Assets Liabilities Outstanding Loans: $300,000 Deposits (Liabilities) : $270,000 Capital (Net worth): $30,000 Total: $300,000 Total: $300,000 Balance Sheet of Crow Bank Assets Liabilities Outstanding Loans: $300,000 Deposits (Liabilities): $285,000 Capital (Net worth): $15,000 Total: $300,000 Total: $300,000 Which bank has a higher leverage ratio? O Pry Bank O Crow BankSuppose both banks' assets increase by 20% to $360,000. Assume that the liabilities of both banks remain the same. Pry Bank's capital increases by V , and Crow Bank's capital increases by V . Therefore, if the value of assets is rising and liabilities do not change, a higher leverage ratio results in a V percentage increase in capital. Now suppose all the items in the balance sheets of both banks return to their initial values. Suddenly, banks realize that loans they made are riskier than they thought, and the total value of their assets declines by 5% to $285,000. Again, assume that the liabilities of both banks remain the same. Pry Bank's capital decreases by V , and Crow Bank's capital decreases by V . Therefore, if the value of assets is falling, a higher leverage ratio means a V percentage decrease in capital. Under this second scenario, which bank is closer to insolvency? O Crow Bank 0 Pry Bank Suppose both banks' assets increase by 20% to $360,000. Assume that the liabilities of both ba , and Crow Bank's capital increases by . Therefore, if the value of asset atio results in a percentage increase in capital. 200% 80% ose all the items in the balance sheets of both banks return to their initial values. Sud thought, and the total value of their assets declines by 5% to $285,000. Again, assum 20% s capital decreases by , and Crow Bank's capital decreases by leverage ratio means a percentage decrease in capital.ose both banks assets increase by 20% to $360,000. Assume that the liabilities of both banks ren 2, and Crow Bank's capital increases by Therefore, if the value of assets is risi age ratio results in a percentage in capital. 300% suppose all the items in the balance sheets of : 400% its return to their initial values. Suddenly, b they thought, and the total value of their asset s by 5% to $285,000. Again, assume that 20% Bank's capital decreases by , and Cr s capital decreases by . Theref age ratio means a percentage decrease in capital.pose both banks' assets increase by 20% to $360,000. Assume that the liabilities of both banks , and Crow Bank's capital increases by .Therefore, if the value of assets is rage ratio results in a percentage increase in capital. suppose all the items greater ance sheets of both banks return to their initial values. Suddenly they thought, and the smaller Je of their assets declines by 5% to $285,000. Again, assume the Bank's capital decreases by , and Crow Bank's capital decreases by The rage ratio means a percentage decrease in capital.se both banks assets increase by 20% to $360,000. Assume that the liabilities of both b , and Crow Bank's capital increases by . Therefore, if the value of asse je ratio results in a percentage increase in capital. uppose all the items in the balance sheets of both banks return to their initial values. Suc hey thought, and the total value of their assets declines by 5% to $285,000. Again, assur nk's capital decreases by , and Crow Bank's capital decreases by ge ratio means a centage decrease in capital. 50% this second scenario, whi 5% is closer to insolvency? O Crow Bank 20%the items in the balance sheets of both banks return to their initial values. Suddenly, banks re it, and the total value of their assets declines by 5% to $285,000. Again, assume that the liab al decreases by , and Crow Bank's capital decreases by .Therefore, if eans a percentage decrease in capital. 75% d scenario, which bank is closer to insolvency? 100% Bank 5%Now suppose all the items in the balance sheets of both banks return to their initial values. Sudde than they thought, and the total value of their assets declines by 5% to $285,000. Again, assume Pry Bank's capital decreases by , and Crow Bank's capital decreases by leverage ratio means a percentage decrease in capital. Under this second scent smaller bank is closer to insolvency? greater Crow Bank