Evaluating a Bank's Profit Approximation
Two commercial banks, 'First Metro Bank' and 'City Central Bank', both have issued $500 million in total loans. They both charge an average interest rate of 6% on their loans and pay an average interest rate of 2% on their deposits. However, First Metro Bank holds $495 million in deposits, while City Central Bank holds $420 million in deposits. For which bank would the profit approximation formula, profit ≈ (interest rate on loans - interest rate on deposits) × total lending, provide a more accurate estimate of its actual profit? Justify your reasoning.
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Conditions for the Bank's Approximate Profit Formula to be Exact
Calculating Bank Profit Using the Interest Rate Spread Formula
A commercial bank has issued a total of $500 million in loans at an average interest rate of 7%. It holds $490 million in customer deposits, on which it pays an average interest rate of 2%. Using the standard approximation method based on the interest rate spread and total lending, what is the bank's estimated profit for the year from these activities?
Evaluating a Bank's Profit Approximation
Rationale for the Bank Profit Approximation
To approximate a bank's profit, the interest rate spread (the difference between the rate on loans and the rate on deposits) is multiplied by the total volume of deposits the bank holds.