Question

If the president of a bank told you that the bank was so well run that it has never had to call in loans, sell securities, or borrow as a result of a deposit outflow, would you be willing to buy stock in that bank? Why or why not?

Short answer

The bank president did not handle the bank satisfactorily. The fact that banks have never incurred expenses due to deposit flows means that banks keep big quantities of reserves that do not acquire any interest. Subsequently, bank gains are extremely down, and bank stocks are not a sound venture.

Step-by-step solution

Step 1:Concept Introduction

The fact that this bank is so well run reflects its high bank (equity) capital. From the equation of EM, this means that the Equity Multiplier is really low which makes the Return on Equity even lower. Therefore, you would not be willing to buy stock in this bank.

Purchasing stocks from a bank

No, purchasing stocks from a bank that is doing too well is not desirable because equity holders manage more about Return on Equity $(ROE)$than Return on Assets$(ROA)$. Remember that $ROE=ROA·EM$and that investors are paid what banks earn on their equity asset. EM is the equity multiplier, estimated as:

$EM=\frac{\text{assets}}{\text{equity capital}}$

$ROA$ponders how effectively a bank is being run since it shows how much profit are yielded by every dollar of resources. A bank can work without a hitch and have a high $ROA$, yet financial backers actually acknowledge little returns since EM is low (when the denominator, value capital, is high). Subsequently, value holders should represent both $ROA$and E M to quantify profits from their ventures, which is R O E.

Stock in the Bank

The bank president did not handle the bank satisfactorily. The fact that banks have never incurred expenses due to deposit flows means that banks keep big quantities of reserves that do not acquire any interest. Subsequently, bank gains are extremely down, and bank stocks are not a sound venture.

Final Answer

The bank president did not handle the bank satisfactorily. The fact that banks have never incurred expenses due to deposit flows means that banks keep big quantities of reserves that do not acquire any interest. Subsequently, bank gains are extremely down, and bank stocks are not a sound venture.