StudentShare solutions
Triangle menu

Credit rationing - Essay Example

Free

Extract of sample
Credit rationing

In cases whereby the compensating balance falls below the minimum required, the interest rate application on the loan will rise accordingly to compensate. A requirement for borrowers by the bank to deposit money is vital to offset part of the loan cost and qualifies it to issue credit to other borrowers and seek alternative investment projects. The individual will only see a low applicable rate of interest on the issued loan. A compensating balance is an account for holding funds and does not generate any interest, and the banks are free to use the money in other investment opportunities. Compensating balance is also known as offsetting balance since its purpose is to offset expenses associated with servicing and the issuing of loans (Mohr 22). The compensating balance thus helps to reduce the cost of provision for loans by the bank, and this generates benefits for both the bank and the borrower from the agreement. In addition to credit, an approach of compensating balances is used to obtain a credit line. The person or corporation taking the credit line just like the loans must agree to maintain a minimum account balance for the loan period. The individual or corporation must have an account already existing with the bank. In cases where the compensating balance drops below the required amount, the interest rates are fixed, so they do not fall back down and are similar, even if the minimum balances in the accounts are restored to their original position. The well known structure for compensating

Related Essays

Principles of Finance
It denotes the combination of equity and debt finance utilised by a corporate entity to finance its assets. While some companies are unlevered, others can be financed partially thorough equity and partially through debt. The determination of the ratio between equity and debt finance is known as the financing decision.
8 pages (2000 words) Essay
MODIGLIANI AND MILLERS ADVICE ON DEBTS IGNORED BY COMPANIES
A response towards the proposition by Modigliani and Miller states that the work fails to portray the inefficiencies presence in the real economic world. The presence as well as determination of maxim capital structure tends to be a constant subject of research in the field of corporate finance.
7 pages (1750 words) Essay
Credit Rationing
In order to maintain a balance between the two, it is compelled to limit its crediting activities within the values of those allowed by a positive ratio. According to a global capital adequacy standard introduced in 1988, this ratio of a bank's capital to its total assets is required by the regulating authorities to be above a minimum appropriate level to reduce the chances of the bank becoming insolvent.
4 pages (1000 words) Essay
Critically examine why financial liberalisation brought financial crisis in most of the Asian countries (for example South Korea, Malaysia, Indonesia and Thaila
A financial market is a place - an actual location such as a stock exchange building or a virtual location such as in a computer - where buyers and sellers agree to buy and sell financial instruments such as stocks, bonds, or derivatives in order to borrow, lend or invest funds for commercial purposes and in a manner that puts financial resources to best use.
8 pages (2000 words) Essay
Land and property Develeopment Diary of the 'credit crunch'
(Even in good times, bankers prefer to lend money only to those who do not need it.) Risk- related restriction in bank lending has been widespread in Southeast Asia throughout 1998. The flight to quality takes the form of a dash to purchase government bonds, believed to be risk-free.
7 pages (1750 words) Essay
Critically evaluate the banking system in Switzerland
A new law that allows foreign banking institutions to run branch offices in Switzerland without authoritization by the FBC. Another law on investment funds was also enacted at the same time. This law abolished limitations associated with assets investment funds The "Federal Law on Combating Money Laundering in the Financial Sector" came to force in 1998 and enhanced due diligence obligations on the part of all financial intermediaries.
6 pages (1500 words) Essay
Money
ing as the middleman or go-between among lenders and borrowers; a good example of a financial intermediary are the banks and other financial institutions which accept deposits from people who have extra monies and lend these out to those who need them and willing to pay interest
3 pages (750 words) Essay
Credit crunch
In such condition, the connection between the interests rates and the availability of credit has unconditionally changed in such a manner that either the loan is fundamentally less than any quoted formal rate of interest or there stops to be a precise
10 pages (2500 words) Essay
ASIA PACIFIC BUSINESS
However, the neoclassical paradigm has been criticized by the proponents of government intervention on economies. This discussion forms the background of our analyses of the Asia Pacific in which we look
4 pages (1000 words) Essay
Analyze Financial Statement
The higher the ratio the better hence some consideration has to be taken over the drop on profit margin in the year 2015 before the loan is advanced. Return on equity is a ratio of net income to the shareholders equity. It indicates the profit the entity makes for its
2 pages (500 words) Essay
balance is simple and is referred to as the 10 and 5 compensating balance. The structure requires the investor borrowing funds to have 10% as a minimum of the issued credit line in the account at the time the credit line is created, and an extra five percent prior to drawing against the line of credit. That suggests that if a line of credit worth $100,000 was established, then a minimum $10,000 is required in the borrower’s account at the time of committing to the credit line. The balance in the compensating account will be $15,000 by the time the credit line is looked at, and drawn on. To ascertain the effective rate of interest of a compensating balance loan, the interest rate is divided by one minus a compensating balance which is revealed in decimal. The formula is as the follows; Effective rate of interest of a compensating balance = interest rate/ (1-compensating balance in decimal form) For example, a compensating loan with a 9 percent rate and 30% compensating balance has an effective rate of 12.85% (0.09 / (1-0.3) =0.1285). The calculation on interest rates on a compensating balance and installment loan will assist an individual or a business entity as investors to understand the true cost of debt. Credit rationing is the situation whereby lenders limit the supply of extra credit to borrowers who demand funds. This occurs although they are willing to pay higher interest rates on those funds. This is an example of market failure or imperfection because the price mechanism fails to bring about equilibrium in the market (Mohr 35). This is a situation whereby, at the prevailing market rates, the demand exceeds the supply, but the lenders are less likely to either issue extra funds or increase the rate of interest charged as they are currently maximizing on profits made. Credit rationing

Summary

Surname: Instructor: Course: Date: Credit Rationing Compensating balance is the minimum balance that must be held by an account and qualify an investor whether an individual or a company for the qualifications of a loan. For example, if an investor borrows $100,000 and the bank requires a deposit of $10,000 then that is a compensating balance loan…
Author : daphneoconner
Credit rationing essay example
Read Text Preview
Comments (0)
Rate this paper:
Thank you! Your comment has been sent and will be posted after moderation