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Chapter 27: Q.16 (page 662)

How can a bank end up with negative net worth?

Short Answer

Expert verified

The bank's worth goes negative when the highest number of borrowers does not repay the loan amount to the bank.

Step by step solution

01

Concept Introduction

When a bank will have liabilities worth more than the assets then that bank has a negative net worth. Negative net worth may occur when the number of defaulters is more than expected.

02

Explanation

There are borrowers who do not repay their loan amount. When a bank has more loan defaulters than expected it will face a decline in its value and the worth of the bank goes negative since the liability will be more than the assets. Thus, the bank's worth goes negative when the highest number of borrowers does not repay the loan amount to the bank.

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Most popular questions from this chapter

Imagine that you are in the position of buying loans in the secondary market (that is, buying the right to collect the payments on loans) for a bank or other financial services company. Explain why you would be willing to pay more or less for a given loan if:

  1. The borrower has been late on a number of loan payments
  2. Interest rates in the economy as a whole have risen since the bank made the loan
  3. The borrower is a firm that has just declared a high level of profits
  4. Interest rates in the economy as a whole have fallen since the bank made the loan

How do you calculate a bank's net worth?

What are a bank's assets? What are its liabilities?

31. Humongous Bank is the only bank in the economy. The people in this economy have \(20million in money, and they deposit all their money in Humongous Bank.

a. Humongous Bank decides on a policy of holding 100%reserves. Draw a T-account for the bank.

b. Humongous Bank is required to hold 5%of its existing \)20million as reserves, and to loan out the rest. Draw a T-account for the bank after it has made its first round of loans.

C. Assume that Humongous bank is part of a multibank system. How much will money supply increase with that original $19million loan?

Explain what will happen to the money multiplier

process if there is an increase in the reserve

requirement?
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