Problem 2 (The Monetary System) We are given the following information about financing structure and asset composition of First Bank and Second Bank Balance Sheet for First Bank Assets Liabilities and Equity Reserves 110.00 1,000.00 Deposits Equity Loans 900.00 100.00 Net Fixed Assets 90.00 Balance Sheet for Second Bank Assets Liabilities and Equity Reserves 100.00 Deposits 760.00 Loans 740.00 Equity 160.00 I Net Fixed Assets 80.00 Government regulation of depository institutions require a minimum reserve requirement of 10 percent at end of each day, Reserve ratio is calculated with following formula: Reserves Reserve ratio Total assets (a) confirm that both banks have sufficient reserves and comply with the reserve regulation. Government regulation of depository institutions require a minimum capital requirement of 9 percent at end of each week. Capital ratio is calculated with following formula: Equity Capital ratio = Total assets (b) Confirm that both banks are adequately capitalized (le, they both have sufficient equity) and comply with the capital regulation. Early one Monday morning, suppose that a bank run occurs resulting in both banks losing 15 percent of their deposits till noon that day. Both banks have access to all their reserves at the Fed in such short notice. Should need arise, banks can sell their loans at a fire sale, but they will only receive 75 cents for every $1.00 loan contract sold in capital markets. (c) As a first order of business, bank managers are not worried about government regulation and try to make sure they can pay depositors withdrawing their funds. Show the balance sheet for both banks at noon when the bank run stops. In the afternoon of the same day, both banks are reminded by the Fed that they are lacking sufficient reserves and that they should increase reserves back to the 10 percent minimum requirement level. Both banks can engage in additional fire-sale of loan contracts. There is not enough time to go to shareholders and ask them to inject capital into the business. (d) Show the balance sheet for both banks at end of day after which both banks make sufficient sale, and they are both compliant with minimum reserve requirement. Assume that the balance sheets for both banks remain the same during the week until they yet receive a new notification from the FDIC suggesting banks with more than 9 percent capital are compliant with minimum capital regulations and are sufficiently capitalized. Any bank with capital ratio between 6-9 percent is deemed undercapitalized and should pay an additional deposit insurance premium. Lastly any bank with capital less than 6 percent will be taken over by the FDIC and placed in conservatorship. (e) How much equity, as percent of original equity, is wiped out of the balance sheet of these two banks? (f) Under the current circumstances what is the status of the two banks at the end of the week? Are they adequately capitalized, undercapitalized (and hence need to pay premium), or conservatorship status? (g) Any bank which falls into conservatorship status before end of the week decides to raise capital from its shareholders in order not to lose its bank charter. Would any of the two banks raise capital to reach 6 percent capital level