Two banks have lent $28 million each to a country in an Emerging Market. Bank A
ID: 1113022 • Letter: T
Question
Two banks have lent $28 million each to a country in an Emerging Market. Bank A has total assets of $400 million and a capital to total assets ratio of 8 percent. Bank B has total assets of $500 million and a capital to total assets ratio of 5 percent. Both banks that each of their entire $28 million loan package will be written off as bad loans.
a. Will any of the two banks survive this crisis? (SHOW YOUR CALCULATIONS) Explain carefully.
b. is this a problem of insolvency or illiquidity? Explain.
Explanation / Answer
(a)
For bank A, Capital ($ Million) = Total assets x Capital-Asset ratio = 400 x 8% = 32
For bank B, Capital ($ Million) = Total assets x Capital-Asset ratio = 500 x 5% = 25
Therefore, bank A will be able to survive this crisis, since its capital base is higher than the bad loan ($32 million > $28 million), but bank B cannot survive since its capital base is lower than the bad loan ($25 million < $28 million).
(b) This is a problem of insolvency because the impact is longer term and the bank's capital base will be affected.