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Analyzing a Bank's Lending Decision
A commercial bank's simplified balance sheet is shown at three points in time:
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Time 1 (Before Loan):
- Assets: 100 (Reserves)
- Liabilities: 90 (Deposits)
- Equity (Net Worth): 10
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Time 2 (Immediately After Issuing a 50-unit Loan):
- Assets: 150 (Reserves: 100, Loans: 50)
- Liabilities: 140 (Original Deposits: 90, New Borrower's Deposit: 50)
- Equity (Net Worth): 10
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Time 3 (One Year Later): The borrower has paid 5 units of interest in cash. The bank's balance sheet is now:
- Assets: 155 (Reserves: 105, Loans: 50)
- Liabilities: 140 (Deposits)
- Equity (Net Worth): 15
Analyze the changes to the bank's Equity (Net Worth) between these three points in time. Based on your analysis, what was the bank's primary economic motivation for issuing the loan at Time 2, despite its net worth remaining unchanged at that moment?
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