Arch bank Assets
100000

Liabilities
Deposit liabilities 80000
Capital 20000
Total 10000

Medes bank
Assets 100000

Liabilities
Deposits 95000
Capital 5000

Which bank has a higher leverage ratio?
O Medes Bank
O Arch Bank
Suppose both banks' assets increase by 20% to $120,000. Assume that the liabilities of both banks remain the same. Arch Bank's capital increases by
, and Medes Bank's capital increases by
Therefore, if the value of assets is rising and liabilities do not change, a higher
leverage ratio results in a
percentage increase in capital.
Now suppose all the items in the balance sheets of both banks return to their initial values. Suddenly, banks realize that loans they made are riskier
than they thought, and the total value of their assets declines by 5% to $95,000. Again, assume that the liabilities of both banks remain the same.
Arch Bank's capital decreases by
, and Medes Bank's capital decreases by
Therefore, if the value of assets is falling, a higher
leverage ratio means a
percentage decrease in capital.
Under this second scenario, which bank is closer to insolvency?
O Arch Bank
O Medes Bank
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