If a bank's return on equity remains constant, but the ratio of bank assets to bank capital increases:

Question

Quizplus · Accepted Answer

Return on equity (ROE) is calculated by dividing the net income by total equity. If ROE remains constant, it means that net income is also constant relative to equity.

The ratio of bank assets to bank capital is known as the leverage ratio or the capital adequacy ratio. An increase in this ratio indicates that the bank is using more borrowed funds (assets) relative to its own funds (capital) to generate profits.

If ROE remains constant but the leverage ratio increases, it means that the bank is generating the same amount of net income with more borrowed funds. This implies a decrease in the bank's return on assets (ROA), which is calculated by dividing net income by total assets.

Therefore, the correct answer is B: the bank's return on assets must have decreased.

If a Bank's Return on Equity Remains Constant, but the Ratio