[Pen-l] Question on T Accounts

[Sabri Oncu <sabri.oncu@xxxxxxxxx>]

Bill:

> The assets would be the $1 million, but what are the liabilities?  Would it be my
> ownership stake, i.e., shares of the company that I own?

Yes! There is no Debt so Assets = Share Holders' Equity. It goes like this:

Assets                  Liabilities
____________________________
Cash ($1 M)          Debt    ($0 M)
                            Equity ($1 M)


If you had $1 M and borrowed $1 M, then your T account would have looked:

Assets                  Liabilities
____________________________
Cash ($2 M)          Debt    ($1 M)
                            Equity ($1 M)

In the former, there is no leverage or your leverage ratio is  just 1.
In the latter, there is leverage and your leverage ratio is 2.
Presumably, a "healthy" bank should have a leverage ratio of 8 to 10,
and don't ask me why. This is what they claim. Assuming that 10 is the
best, the T account of a "healthy" bank may look like this:

Assets                  Liabilities
____________________________
Cash ($10 M)        Debt    ($9 M)
                            Equity ($1 M)


In the above, the leverage ratio is 10. After that, things get very
complicated, of course. The above is just the beginning.

Don't forget: in these T accounts, the left is always equal to the right.

Some weird western thinking it must be!

Best,
Sabri
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