Consider the balance sheets of Bank A and Bank B. Assume that reserve requiremen

Question

Consider the balance sheets of Bank A and Bank B. Assume that reserve requirements are 10 percent of transaction deposits and both banks have equal access to the interbank market and funds from the Federal Reserve.
                         

Which bank do you think is at the greatest risk of insolvency?

What other information might you use to assess the risk of insolvency of these banks?

Bank A (in millions) Bank B (in millions) Assets Liabilities Assets Liabilities Reserves          $50 Transaction Deposits           $200 Reserves           $30 Transaction Deposits          $200 Loans            $920 Nontransaction Deposits      $600 Loans              $920 Nontransaction Deposits     $600 Securities      $250 Bank Capital                       $320 Securities         $50 Bank Capital                      $100

Explanation / Answer

Which bank do you think is at the greatest risk of insolvency?

Bank B

What other information might you use to assess the risk of insolvency of these banks?

B) Bank B has lower net worth than Bank A, and so has less of a cushion against interest-rate movements. Therefore, Bank B faces the greater risk of insolvency. Information regarding the interest-rate sensitivity of the assets and liabilities for both banks and their off-balance sheet commitments would be helpful in assessing the insolvency risk.

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