The
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

  • Credit Control
    To keep the amount of loan in the optimum level is known as credit control. In case of individual the person himself maintain the level of optimal ...
  • Dollarization
    Dollarization is the replacement of a foreign currency with U.S. currency with U.S. dollars. This process is a step....
  • Multinational corporations (MNCs)
    Multinational corporations are defined as firms that engage in some form of international business. Their managers conduct international investing and financing decisions that are intended to maximize the value of the MNC.
  • Retire (a Bill of Exchange)
    Retire (a Bill of Exchange) is to pay, or take up before maturity, usually under rebate and thus withdraw (or retire) a bill from circulation.
  • The mark-up model
    This is another variant form of price leadership model. In this case bank uses mark-up for risk & profit over and above interest cost of borrowing in the money market.
  • Loan Risk
    Loan Risk this is the risk of loss from loaning money and having the borrower fail to repay, either due to genuine reasons or willfully
  • Investment Banking
    A specific division of banking related to the finance of capital for other companies, governments and other entities is known as investment banking.