ECON 1740: Your State Bank of Utah Problem Set

IMPORTANT: Do not forget to write your name. Make sure to answer all the questions. When appropriate, show your work (calculations) leading to your answer. Do not reduce your answer to a single number (e.g. “2”) but use a full sentence explaining what the final number means.

The government of Utah gives you permission to open your state bank named “Your State Bank of Utah” (YSBU). After obtaining the charter from the state, you find investors that bring $1,000 in specie to form the capital of the bank (don’t forget the corresponding note on the “asset side” too)

1. After evaluating loan requests from clients, YSBU issues $1,500 in bank notes to costumes for loans payable in 1 year with a simple 5% interest rate per year over the amount lent. What is the total value of YSBU’s assets (do not take expected profits into account when computing assets’ value)? What is the total value of YSBU’s liabilities?

2. What is YSBU’s reserve ratio (remember that the “reserves” part in computing the reserve ration refers to the total amount of space that the bank has)? What is YSBU’s money multiplier? Is YSBU a “partial reserve system” (a.k.a. “fractional reserve”) type of bank? Why or why not? What is YSBU’s expected profit if everything goes well and the principal of the loan and the interests are paid at the end of the year?

3. Is YSBU in danger of having a liquidity crisis? Why or why not? What is the maximum loss in the value of assets that YSBU can suffer without incurring into an insolvency crisis?

4. After passing the National Banking Act in 1863 the Federal Government creates a 10% tax on the total value of notes issued by the state banks. Therefore, ignoring other costs for simplicity, total profits of state banks will be given by interests collected on loans minus taxes paid on notes issued. What are the expected profits of YSBU after the Federal Government creates the tax on notes (again, assume that all the loans are fully repaid with 5% interest)?

5. Imagine that, instead of being a state bank, YSBU becomes a national bank that has to pay a 2% tax on the total value of notes issued (in reality there was no tax on national banks, but let’s imagine there is that 2% on their notes to make the problem set less obvious). What would the profits be for YSBU (assuming the same numbers as before: $1,500 in bank notes to costumes for loans payable in 1 year with a simple 5% interest rate per year; but now with a 2% tax to be paid over the value of notes). What will YSBU decide: to remain as a state bank or become a national bank?