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Analyzing Bank Financial Distress Scenarios
Consider the two scenarios below describing the financial situations of two different banks. Analyze both scenarios and determine which bank is insolvent. In your answer, you must justify your conclusion by explaining how the specific conditions for insolvency are met in one case but not the other, based on the relationship between the banks' assets and liabilities.
Scenario A: Bank A's primary assets are a large number of loans made to commercial real estate developers. Following a sudden and severe crash in the property market, the market value of these loans has fallen dramatically. An independent audit now values the bank's total assets at $800 million, while its total liabilities, primarily customer deposits, remain at $900 million.
Scenario B: Bank B holds a portfolio of long-term government bonds as its main assets, valued at $1.2 billion. Its total liabilities to depositors are $1 billion. A widespread rumor about the banking system causes a panic, and a large number of depositors rush to withdraw their funds simultaneously. The bank does not have enough physical cash to meet all the immediate withdrawal requests and would need several days to sell its bonds to raise the necessary cash.
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