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Chapter 14: Q. 16 (page 352)

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

:Expalantion of solution

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

If you are out shopping for clothes and books, what is easiest and most convenient for you to spend: M1 or M2? Explain your answer.

If you are out shopping for clothes and books, what is easiest and most convenient for you to spend: M1 or M2? Explain your answer.

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

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

a. Humongous Bank decides on a policy of holding\)100reserves. 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?

What is the risk if a bank does not diversify its

loans?
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