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Using the example (simplified) bank balance sheet below show and explain why the Leverage And Capital Ratios are changed as a result of a 6m write-down in mortgages.

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Introduction

Spring Assignment – 2012 Financial Crisis and the National Economy Economics for Accounting and Business (UMECXW-20-1) Part A: Using the example (simplified) bank balance sheet below show and explain why the Leverage And Capital Ratios are changed as a result of a £6m write-down in mortgages. [A]Initial Balance sheet: Liabilities £m Assets £m Risk Weighting Risk Adjusted Assets (£m) Deposits Cash Current accounts 195 Cash in Tills 5 (0%) 0 Time deposits 94 Money at call 5 (0%) 0 Total Liabilities 289 Available for sale assets Gove' Bonds & Bills 10 (10%) 1 Other Bonds & Bills 40 (20%) 8 Equity Shareholder Capital 13 Other assets Retained Profits 3 Loans and Advances 125 (100%) 125 Mortgages 120 (50%) 60 Total Equity 16 Total Liabilities + Equity 305 Total Assets 305 Total Risk- Adjusted 194 UK Liquidity Ratio 3.28% Leverage Ratio 5.25% Capital Ratio 8.25% [B] Balance sheet after a write-down of £6m on Mortgages: Liabilities £m Assets £m Risk Weighting Risk Adjusted Assets (£m) Deposits Cash Current accounts 195 Cash in Tills 5 (0%) 0 Time deposits 94 Money at call 5 (0%) 0 Total Liabilities 289 Available for sale assets Gove' Bonds & Bills 10 (10%) 1 Other Bonds & Bills 40 (20%) ...read more.

Middle

1. From the table we can see, given the bank has£10 in total equity. From 1 X is given £15.28m. X-£10m=£15.28m-£10m=£5.28m. In conclusion, bank needed additional equity £5.28m from the existing equity of £10m to achieve the total equity of £15.28m so that the capital ratio of 8% can be achieved. 1. The second method is by decreasing risk-adjusted assets (with no change in equity) 1. With no change in equity, we calculate the total risk-adjusted assets. Using £10m in equity The total risk-adjusted assets=£10m/8% *100%=£125m. In conclusion, assume total equity is fixed; the total risk-adjusted assets have to decrease to £125m in order to achieve the capital ratio of 8% 1. Form the table, we can see, current risk-adjusted asset =£191m and the target risk-adjusted asset =£125m. The change of risk-adjusted asset =new risk-adjusted assets-old risk-adjusted assets=£125m- £191m=-£66m. In conclusion: the total risk-adjusted assets must reduce by £66m in order to get £125m so that the capital ratio of 8% can be achieved. 2. We now have to change the composition of Assets to make risk-adjusted assets=£125m Because the risk weight of loans and advances is 100%. We need to make it smaller, old loans and advances=£125m, new loans and advances=old loans and advances +changes in composition of assets=£125m+ (-£66m) ...read more.

Conclusion

Assuming the entire bank do that, the aggregate will fall due to the falling of the consumption of domestically produced goods & services and the investment. All of these are depend on loans. For people, they want to take loans from banks by buying cars and house. They also want to pay the educational fees. For the firms, they are in trouble they cannot finance the loans. Sometimes, they don?t have enough money to buy the new equipment and pay the salary to their employees, so they take loans from banks, the issue is they cannot take enough loans from banks so as to firms are tending to make less investment. Due to rebuilding capital ratio, banks don?t want to give loans to others, the Cd will fall down. As a result, the economic will go into the recession. The economic will experience a huge fall in terms of their aggregate demand. Also, the banks start to rebuild the capital ratio by increasing the equity. Through increasing retained profit, it can delay the payment of dividends and increase its loans rates & bank charges, or by laying off staff and closing underperforming branches so that it will cause the increasing of the unemployment rate and reducing spending. Everything is tending to fall. Spending lesser and lesser, the aggregate demand will fall. Thus, GDP will fall leading to the recession. ...read more.

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