Problem 409 What is the basic principle of t... [FREE SOLUTION] (2024)

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Chapter 12: Problem 409

What is the basic principle of the commercial loan theory of banking?

Short Answer

Expert verified

The basic principle of the commercial loan theory of banking is that banks primarily act as intermediaries between savers and borrowers, generating income through the interest rate spread between deposits and loans. Banks profit from lending at higher interest rates than the rates they offer on deposits, while maintaining a balance between lending and deposit-taking to ensure long-term profitability and financial stability.

Step by step solution

Definition of Commercial Loan Theory of Banking

The commercial loan theory of banking is an approach to banking where banks generate income primarily by issuing loans to borrowers, such as individuals and businesses. Banks lend money at a higher interest rate than the rate they offer for deposits, and this interest rate spread allows the banks to profit from the lending operation. Also, the borrowers are expected to maintaining a certain level of deposits at the bank, thereby providing banks with additional capital to issue more loans.

Basic Principle of Commercial Loan Theory

The basic principle of the commercial loan theory of banking is that banks mainly act as intermediaries between savers who deposit their funds in the banks, and borrowers who seek loans for various purposes. Banks make money by charging higher interest rates on loans compared to the interest rates they pay for deposits. The commercial loan theory states that banks should maintain a balance between lending and deposit taking to ensure their long-term profitability and financial stability.In summary, the basic principle of the commercial loan theory of banking is that banks generate income by acting as intermediaries between savers and borrowers and profiting from the interest rate spread between deposits and loans while maintaining a balance between lending and deposit taking.

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Most popular questions from this chapter

When a security has a maturity value of $\$ 100,000$ and the coupon rate is $5\%$, what are you willing to pay for it when it is due next year and the yieldis $9 \%$ ?Suppose Mr. $\mathrm{X}$ has a checking account in Bank A, and Mr.$\mathrm{Y}$ has a checking account in Bank B. Banks A and B each have $\$100,000$ in deposit liabilities and $\$ 30,000$ in reserves, and the requiredreserve ratio is $20 \%$. Show what happens to each bank's depositliabilities, reserves, and excess reserves if Mr. X writes a check for $\$10,000$ to Mr. Y, Mr. Y deposits the check into his account at Bank$\mathrm{B}$, and Bank $\mathrm{B}$ collects from Bank A.How did the government stand behind the banks through the formation of theFederal Deposit Insurance Corporation?What is meant by a bank loan that is called a 7 percent discount?Suppose the banking system as a whole has $\$ 100,000,000$ in deposits, withno excess reserves. What is the potential change in the money supply if theFed a) lowers the reserve requirement from $25 \%$ to $20 \%$; b) raises the reserve requirement from $25 \%$ to $331 / 3 \%$ ?

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