Figure 5.19: Nominal Policy Rate and Market Interest Rates in the United States

Commercial Banks as Profit-Maximizing Firms

Loan Application Analysis

A commercial bank is evaluating two loan applications for the same amount of money. Applicant A has a high credit score and is applying for a 5-year car loan. Applicant B has a low credit score and is applying for a 30-year mortgage. Assuming the central bank's policy rate and the level of banking competition remain constant, which applicant is likely to be offered a higher interest rate and why?

Analyzing an Unexpected Loan Rate

Match each scenario with its most likely effect on the interest rate a commercial bank would offer on a loan, assuming all other factors remain constant.

A 1% decrease in the central bank's policy rate will automatically cause commercial banks to lower their 30-year mortgage rates by exactly 1%.

Deconstructing a Bank's Lending Rate Decision

A country's banking industry, historically dominated by a few large institutions, experiences the entry of several new, highly competitive digital banks. Assuming the central bank's policy rate and the average creditworthiness of borrowers do not change, what is the most probable impact on the interest rates charged for consumer loans?

Interpreting Conflicting Economic Signals

Deconstructing a Loan Interest Rate

A small business owner with a moderately risky business plan is seeking a 10-year loan. In the same week, two major events occur: the central bank significantly raises its policy rate, and a major competitor bank in the region suddenly closes, reducing local banking competition. Based on this scenario, arrange the following factors in order from the one likely to have the largest upward impact on the interest rate offered to the business, to the one with the smallest upward impact.

Higher Interest Rates as Compensation for Unavoidable Risk