Consider two banks, call them A and B. On January 1, 2020, bank A had reserves of $15 billions, loans of $85 billions and no other assets, while bank B had reserves of $30 billions, loans of $70 billions and no other assets. Also, on January 1, 2020, bank A had deposits of $96 billions and no other liabilities, while bank B had deposits of $90 billions and no other liabilities.

During the first quarter of 2020, the net income of Bank A was $1.0 billion while net income of bank B was also $1.0 billion.

(i) Calculate the rate of return on assets, ROA, and the rate of return on equity, ROE, of each of the two banks during the first quarter of 2020.

Explain why ROE of bank A is significantly higher than ROE of bank B. (2 marks)

(ii) Suppose that at the end of first quarter, both banks experienced 5% default on their loans. Assuming no other changes, find the equity of each bank after the 5% loan defaults. (3 marks)

(iii) Explain why does the 5% default on loans leads to insolvency of bank A, not of bank B.

(4 marks)