Consider Bank A, which currently has $195 worth of loans and $5 in cash as its assets, and $190 of demand deposits as its only source of debt. The interest rate on the loans is 5 percent and the bank pays 3 percent interest on the demand deposits.

a. Calculate any relevant measures of the banks profitability.

b. Now suppose regulators (1) require that the bank pay $1 per year in deposit insurance premiums and (2) impose a capital requirement of 10% of assets (the Bank will maintain the same assets, but change its capital structure). As a result of the regulation, Bank As cost of debt falls to 2%. Re-calculate the relevant measures of the banks profitability.

c. What is the net effect of the new regulatory burden on Bank A?