The following is a balance sheet of a commercial bank (in millions of dollars).
Assets Liabilities and Equity
Cash $ 5 Insured deposits $30
Loans 40 Uninsured deposits 10
Equity 5
Total assets $45 Total liabilities and equity $45
The bank experiences a run on its deposits after it declares it will write off $10 million of its loans as a result of nonpayment. The bank has the option of meeting the withdrawals by first drawing down its cash and then by selling off its loans.
A fire sale of loans in one day can be accomplished at a 10 percent discount. They can be sold at a 5 percent discount if sold in two days. The full market value will be obtained if they are sold after two days.
a. What amount do the uninsured depositors lose if the FDIC uses the insured depositor transfer method to close the bank immediately? The assets will be sold in four days.
(Hint: State the consequences for the uninsured depositors, insured depositors and equity holders.)
b. What happens in the result of (a) if that the assets could not be sold in four days?