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.
More from this Section
- Acceptance Credit
Acceptance Credit is a documentary credit, which requires, amongst the documents stipulated, provision of a term bill of exchange.
- Correspondent banking
Correspondent banking is a system of formal and informal relationships among large and small banks established to facilitate the
- Confirming Bank
Confirming Bank is the bank, which, upon authorization or request of the issuing bank, adds its confirmation to the documentary credit.
- Fully amortized loan
Fully amortized loan is a credit market instrument that provides a borrower with an amount of money that is repaid by making a fixed payment periodically (usually monthly) for a set number of years.
- Real bills doctrine
Real bills doctrine is a guiding principle (now discredited) for the conduct of monetary policy that states that as long as loans are made
- Time series Analysis
Time series Analysis is an analysis of relationships between two or more variables over periods of time.
- The Capital/Financial Account of the BOP
The Capital/Financial of the balance of payments measures all international economic transactions of financial assets. It is divided into two major components ...