This question is designed to inspire you to think about the effects of COVID19

on the management of a commercial bank.

Suppose a banks original T-account is de-

picted as follows:

Table 1: T-Account for Bank A in February 2020

Assets

Liabilities plus Equity

Loans: $ 800

Deposits: $1200

Securities: $ 400

Borrowings: $400

Reserves: $ 600

Equity: ?

The interest rate on loans is 8%, the average return for securities is 5%, the interest rate

on reserves is 2%, the interest rate on deposits is 1%, the interest rate on borrowings is

1.5%.

Please answer the following questions based on the information shown in Table 1.

1. Please calculate the equity value, the leverage ratio, the capital ratio and the return

on equity?

2. In March 2020, the financial risk becomes higher because of the outbreak of the

COVID19.The bank decides to raise the loan rate to 12%. The return on securities

declines to -5% because of the stock market crash. At the same time, the Federal

Reserve lowered the interest rate on a commercial banks borrowing to 0.5%.The

interest rate on deposits and reserves are also lowered to 0.5%. With the new

interest rates, what is the new return on equity if the balance sheet is still as

described in Table 1.

3. The outbreak of COVID19 in March 2020 may affect the management of a com-

mercial bank in the following ways. First, the value of securities decreases to $320

because the stock price plunged significantly. Second, $50 loans get defaulted be-

cause the borrowers financial situation deteriorates. Third, depositors needs to

withdraw $200 dollars to maintain their living. With the above three changes,

what does the commercial banks new balance sheet look like? Is the bank going

to be insolvent? What is the new capital ratio? Based on your calculation of the

capital ratio, is the bank facing a higher or lower risk of going bankruptcy?