Does it really make a difference if a S&L has a 20% ratio or 1%? If a bank/S&L has zero or negative equity they can still stay open for business as long as their depositors don't withdraw all their funds, right??
Please help me!! Im not so smart and need a simple explanation.
2007-05-25 06:45:13 · 1 answers · asked by KhrisB 3 in Business & Finance ➔ Investing
It's best to explain the equity/assets ratio for banks this way...
Assume you are a bank and have no equity. That means you lend out monies you have borrowed from someone else (because you have no equity, you have no money of your own). If someone does not pay you back for your loans, you will not be able to meet your own loans - this means you close your doors. This is not safe for your other clients. This is why no banks have 100% debt.
Assume you are heavily in debt but have a bit of equity. Again, you run into the same problem. If your depositors take out more money than you anticipate, you can give money to your clients for their loans. If someone doesn't pay you back, you get closer to closing your doors.
The key then is to have a nice balance of debt and equity. After all, if you have all equity, that's an expensive way to finance these loans you are providing. If you have all debt, you run into financial distress.
The Federal Reserve and FDIC also regulates your reserve levels. These are so you always have enough money to meet demands by your depositors. In addition, your financial strength is directly correlated to the interest costs you pay for borrowing money to lend to others.
I hope that answers your question.
2007-05-25 08:05:26 · answer #1 · answered by Tats 3 · 0⤊ 0⤋