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Onshore Bank has $20 million in assets with risk-adjusted assets of $10 million. CET1 capital is $500,000, additional Tier I capital is $50,000, and Tier II capital is $400,000. How will each of the following transactions affect the value of the CET1, Tier I, and total capital ratios? What will the new values of each ratio be? a. The bank repurchases $100,000 of common stock with cash. b. The bank issues $2 million of CDs and uses the proceeds to issue category 1 mortgage loans with a loan-to-value ratio of 80 percent.

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Answer:

Explanation:

If the bank repurchases $100,000 0f the common stock with  cash, CET 1capitaldecreases to $400,000 ($500,000 - $100,000).

The Tier I capital decreases to $450,000 ($500,000 + $50,000 - $100,000).

The Tier II capital is $400,000.

The total capital decreases to $850,000 ($400,000+$50,000+$400,000).

We need to calculate the new ratios

CET 1 ratio = decreased  CET 1 capital/risk-adjusted assets

                  =  $400,000/$10,000,000

                  = 4.00%

Tier 1 ratio = decreased  Tier 1 capital/risk-adjusted assets

                  = $450,000/$10,000,000 = 4.50%

Total capital ratio = decreased total capital/risk-adjusted assets

                              =  $850,000/$10,000,000

                              = 8.50%

b) The uninsured mortgages have a risk weight of 35%.

Hence, the risk-weighted assets increase to $10,700,000 ($10,000,000 +$2,000,000*35%).

Hence, we have to calculate the new ratios.

CET 1 ratio = decreased  CET 1 capital/risk-adjusted assets

                  =  $500,000/$10,700,000

                  = 4.67%

Tier 1 ratio = decreased  Tier 1 capital/risk-adjusted assets

                  = $550,000/$10,000,000

                  = 5.14%

Total capital ratio = decreased total capital/risk-adjusted assets

                             =  $950,000/$10,000,000

                             = 8.88%

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