Bank Capital and Asset Management

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Why do banks hold reserves according to the text?

To comply with reserve requirements by the Fed or Bangko Sentral of the Philippines (correct)

To maximize profits from loans

To earn interest payments

To make it harder for depositors to withdraw funds

What are bank assets referred to as, according to the text?

Income-earning assets (correct)

Reserve assets

Profit-making assets

Excess assets

What is the main purpose of excess reserves held by banks?

To earn higher interest rates

To increase lending capacity

To meet withdrawal obligations (correct)

To pay off creditors

What is the significance of the required reserve ratio set by regulatory authorities?

To regulate the amount of reserves banks must keep Signup and view all the answers

What does insolvency mean for a bank according to the text?

Having more liabilities than assets Signup and view all the answers

Why do banks hold cash items in the process of collection according to the text?

To increase liquidity Signup and view all the answers

Why do loans have a higher probability of default according to the text?

As a result of their liquidity constraints and higher default risk Signup and view all the answers

What is the main reason a bank makes its highest return on loans?

Due to their higher interest rates Signup and view all the answers

What is asset transformation in banking?

The practice of using deposits to fund long-term loans Signup and view all the answers

Which category of loans is mentioned as one of the largest for commercial banks in the U.S.?

Commercial and industrial loans Signup and view all the answers

What does a T-account in banking represent?

A simplified balance sheet that lists changes in balance sheet items Signup and view all the answers

How does a bank typically fund its long-term loans according to the text?

By using short-term deposits Signup and view all the answers

What is the bank's excess reserves after the deposit outflow in the first scenario?

$1M Signup and view all the answers

What is the total amount of assets and liabilities for the bank?

$100M Signup and view all the answers

Why is it mentioned that excess reserves are an insurance against the costs associated with deposit outflows?

To explain the purpose of excess reserves in liquidity management Signup and view all the answers

What happens to the bank's balance sheet when it makes additional loans without keeping sufficient excess reserves?

Assets decrease and liabilities increase Signup and view all the answers

What does borrowing $9M from other banks or corporations do to the borrowing bank's balance sheet?

Increases total assets Signup and view all the answers

What action can a bank take to address a shortfall in reserves when in violation of the required reserve ratio?

Borrow from other banks or corporations Signup and view all the answers

Why do banks need to decide on the amount of capital they need to hold?

To prevent bank failure and satisfy obligations Signup and view all the answers

In the scenario described, what happens to a bank's equity when its assets decline?

Equity declines Signup and view all the answers

What is the purpose of bank capital requirements set by regulatory authorities?

To maintain financial stability and prevent defaults Signup and view all the answers

How does having a higher capital-to-assets ratio benefit a bank during economic downturns?

It minimizes the impact of asset losses on the bank's equity Signup and view all the answers

What would happen to a bank's capital if its loans drop by $5M but its net worth remains positive?

Capital remains the same Signup and view all the answers

Why is it crucial for banks to hold an adequate amount of capital according to the text?

To prevent bank failure and insolvency Signup and view all the answers

What does the equity multiplier measure?

The amount of assets per dollar of equity capital Signup and view all the answers

Which bank has a higher equity multiplier according to the text?

Low Capital Bank Signup and view all the answers

Why are the equity holders of Low Capital Bank happier than those of High Capital Bank?

Because Low Capital Bank has a higher equity multiplier Signup and view all the answers

What is the relationship between bank capital and the return on equity for owners?

Bank capital decreases the return on equity for owners Signup and view all the answers

How does reducing bank capital affect the return for owners according to the text?

It increases Signup and view all the answers

Why is bank capital considered costly according to the text?

Because it reduces the return on equity for owners Signup and view all the answers