Consider a balance sheet for First Street Bank $100,000 in mortgage loans, $60,000 in commercial loans, $10,000 in securities, $10,000 in loans to other banks, $20,000 in reserves, $190,000 in deposits, and bank capital of $10,000. The desired reserve ratio is 8%.

a. Fill the balance sheet with the above given information.

b. Calculate the traditional leverage ratio. Is the bank well capitalized?

c. Calculate the risk weighted capital-asset ratio. Is this bank fulfilling the Basel capital requirement?

d. Suppose there is a default of $50,000 in mortgage loans and the bank takes ownership of these houses. How is the balance sheet affected? Show the new balance sheet with housing as a new category.

e. Using your answer to part

d. assume next that housing prices fall by 50% as part of a general deflation. Show the effect of this change on a new balance sheet (Hint: what is effect on value of housing and capital)

f. How does deflation threaten this bank? Based on this example explain the need for capital requirements