Kansas Bank has a policy of limiting their loans to any single customer so that the maximum loss as a percent of capital will not exceed 20 percent for both secured and unsecured loans.The limit has been adopted under the assumption that if the unsecured loan is defaulted, there will be no recovery of interest or principal payments.For loans that are secured (collateralized), it is expected that 40 percent of interest and principal will be collected. Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized) loan is 10 percent (as a percent of capital).If it wishes to keep a concentration limit at 40 percent for secured loans, what is the estimated amount lost per dollar of defaulted secured loan?

Question

Quizplus · Accepted Answer

For a secured loan, Kansas Bank expects to recover 40% of the principal and interest. If the bank wants to ensure that its maximum loss on a secured loan is 10% of its capital and is willing to lend up to 40% of its capital, then the calculation would be as follows: If the bank lends 40 cents on the dollar (40% of its capital), and expects to lose only 10 cents on the dollar (10% of its capital) in the event of a default, it means the bank expects to recover 30 cents on the dollar (40 cents - 10 cents). However, since the bank actually recovers 40% of the amount lent in the event of a default, to find the estimated amount lost per dollar of defaulted secured loan, we consider the initial expectation of recovery (40% of the loan). The discrepancy in my explanation indicates a misunderstanding of the question's requirement. The correct approach should focus on the loss given the recovery rate and the maximum loss limit as a percentage of capital, not directly on the recovery from the loan. The estimated loss per dollar of defaulted secured loan should reflect the difference between the total loan amount and the recovered amount, considering the bank's policy and assumptions.

Kansas Bank Has a Policy of Limiting Their Loans to Any