Metrobank offers one-year loans with a 9 percent stated rate, charges a 1/4 percent loan...

Question:

Metrobank offers one-year loans with a 9 percent stated rate, charges a 1/4 percent loan origination fee, imposes a 10 percent compensating balance requirement and must pay a 6 percent reserve requirement to the Federal Reserve. What is the return to the bank on these loans?

Bank Loan Return:

The required return on the loan by a bank will be higher if the loan is deemed riskier. The return will also depend on some other specifics of the loan, such as origination fee, compensating balance, and the reserve requirement.

Answer and Explanation:

We can use the following formula to compute the promised return:

  • {eq}\dfrac{f + br + rp}{1 - b(1 - RR)} {/eq}

where {eq}f{/eq} is the origination fee, {eq}br{/eq} is the base rate, {eq}rp{/eq} is the risk premium, {eq}b{/eq} is the compensating balance, and {eq}RR{/eq} is the reserve requirement.

Applying the formula, the promised return in this question is:

  • {eq}\dfrac{0.25\% + 9\% + 0\%}{1 - 10\%(1 - 6\%)} = 10.21\% {/eq}

Learn more about this topic:

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Buying a House: Mortgage Types & Loan Length

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