Consider Bank A, which currently has $195 worth of loans and $5 in cash as its assets, and $190 of demand deposits as its only source of debt. The interest rate on the loans is 5 percent and the bank pays 3 percent interest on the demand deposits.

 Now suppose regulators 

(1) require that the bank pay $1 per year in deposit insurance premiums and 

(2) impose a capital requirement of 10% of loans. As a result of the fact that depositors are now covered by deposit insurance and the bank will be granted access to the Central Bank's discount window, Bank B's cost of debt will fall to 1%. 

Re-calculate the relevant measures of the bank's profitability.

Would you say that the net effect of this regulation on Bank B is positive or negative? Justify your answer

Answer rating: 100% (QA)

Lets recalculate the relevant profitability measures for both banks under the new regulations For Ba... View the full answer