Definition Of

The caps rates model

Under this variant form of price leadership model, the bank sets a interest rate caps beyond which the interest can’t move up. If the market interest rate rises, the caps will be effective & bank will continue to finance the borrower even if the caps interest rate is smaller than the market interest rate.

Say in the earlier example Bank Alfala Ltd. Is offering credit to a customer on the term that it will charge prime rate or bank rate plus 2% with caps of 5%. If the short term bank rate is 6%. Then the initial loan pricing will be at (6%+2%) =8%, with the highest interest rate to be charged to the customer will be no more than 8%+5%=13%.

This method is popular in countries where loan interest rate changes continuously. The benefit is that under adverse movement of base interest rate in the economy this model provides some reassurance that the cost of fund will not be more than 13% for the borrower under this agreement.

Share it:

More from this Section

  • Tax Incentives
    Tax Incentives is tax benefits. Most tax incentive measures fall into one or more of the following categories: tax exemption (tax holiday);
  • Technical Analysis
    Technical analysts, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.
  • Demand Draft
    Demand Draft is a Bill of Exchange payable at sight or on demand.
  • Credit Scoring System
    Credit Scoring System is a statistical system used to determine whether or not to grant credit by assigning numerical scores to various
  • Securitization
    Securitization is the process of transformation of a bank loan into tradable securities. It often involves the creation of a separate .
  • Bill of lading (B/L)
    Bill of lading (B/L) is contract between a common carrier and a shipper to transport goods to a named destination. The bill of lading is also a receipt for ...
  • Tax Haven
    Tax Haven is an international banking and financial centre providing privacy and tax benefits