Final answer:
Metrobank's actual return on a one-year loan considering the stated interest rate, loan origination fee, compensating balance requirement, and reserve requirement set by the Federal Reserve, is approximately 16.59%, slightly higher than the 16% stated rate.
Step-by-step explanation:
In examining the profitability of a loan provided by a bank, such as Metrobank, it is essential to consider not only the stated interest rate but also additional costs and requirements such as loan origination fees, compensating balance requirements, and reserve requirements set forth by the Federal Reserve. To determine the actual return to the bank on these loans, we need to account for these factors.
Firstly, Metrobank charges a 0.5% loan origination fee. This fee increases the cost to the borrower and thus effectively increases the amount the bank earns upfront. For a $100 loan, the bank would earn $0.50 through this fee.
Secondly, a 12 percent compensating balance requirement effectively restricts the amount of money the borrower can use. If the loan amount is $100, the borrower must maintain $12 in their bank account, which cannot be utilized. This means the bank only effectively lends out $88.
Now, not all of the $88 will be available to the bank for other uses since the Federal Reserve imposes a 4 percent reserve requirement. This reserve requirement reduces the amount the bank can earn interest on further. In our example, this means that $3.52 of the $88 must be set aside, leaving the bank with effectively $84.48 to earn interest upon.
The bank's stated interest rate of 16 percent is applied to the effectual loan amount after compensating balance and reserve requirements. On a $100 nominal loan amount with the aforementioned stipulations, the bank would earn $13.52 in interest ($84.48 * 16%). Considering the origination fee, the total return to the bank is $14.02.
To calculate the return as a percentage, we divide the bank's earnings by the effective loan amount after all requirements, which would be $14.02 / $84.48, resulting in a percentage of approximately 16.59%. This return rate reflects the true earning power of the loan to the bank, which is slightly higher than the 16% stated rate due to the additional fees and requirements.