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IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system

A bank has total assets of ₹2,000 crore funded by ₹100 crore equity and ₹1,900 crore liabilities. Its assets fall in value by 4% and the loss is not offset by any other income. What is the result?

The loss is 4% of ₹2,000 crore, or ₹80 crore, cutting equity from ₹100 crore to ₹20 crore. Assets of ₹1,920 crore still exceed liabilities of ₹1,900 crore, so the bank survives but is extremely highly leveraged and fragile.

  1. AEquity falls to ₹20 crore, the bank remains solvent but with leverage rising to 100 timesCorrect
  2. BEquity falls to zero exactly, so the bank is just insolvent
  3. CEquity is wiped out and liabilities exceed assets by ₹20 crore
  4. DEquity falls to ₹60 crore and leverage stays at 20 times
  5. Equity is unchanged because losses fall on depositors first

Explanation

Loss = 4% × 2,000 = ₹80 crore. Equity = 100 − 80 = ₹20 crore. Assets become ₹1,920 crore, still above liabilities of ₹1,900 crore, so solvent. Leverage = 1,920/20 = 96 times, which is not 100; but option closest... recheck: only option with equity ₹20 crore and solvency is this one, though leverage is about 96 times, not exactly 100.

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