A bank is allowed to lend upto 72% of its deposits. If the average rate at which funds are lend is 14.75%, what is the maximum rate that the bank offer on deposits.
The bank is allowed to lend up-to 72% of its deposits. The average rate at which funds are given as loans is 14.75%. If the bank could use all the funds deposited with it and give them as loans it would theoretically break-even if the depositors were given an interest rate of 14.75%. Here, this is not the case. If the bank gives its depositors an interest rate of r, and assuming no other costs are involved, for the bank to break even the following equation has to be satisfied: D*r = 0.72*D*0.1475. The value of r that satisfies the equation is 10.62%.
The highest interest rate that the bank can give its depositors is 10.62%. It should be noted that the usual interest rate is substantially less than this as banks are entities created to make a profit and the interest differential also has to cover for all operational expenses of the bank.