The First Knox National Bank is concerned about its use of leverage.
a) Is it right to be worried if it faces a loss on its portfolio of loans equal to 10%? [let R=10%].
First Knox National Bank
Assets Liabilities
Reserves $100m. Deposits $1000m
Loans $950m. Equity (capital) $50m.
b) Can the loss to depositors be calculated? If it can, please compute it.
c) If the depositors are insured (by the FDIC), explain the potential role of moral hazard in this case.