Question

27. Which of the following would not increase a bank’s Net Interest Margin, assuming all else stays the same? Choose two a) an increase in the interest rate on its loans b) corporate borrowers paying off some of their loans and the bank using the funds to invest in Treasury notes Yes c) customers switching a portion of their time deposits to demand deposits d) the bank issues additional equity and keeps the funds in cash e) a decrease in the federal funds rate assuming the bank borrows more in the federal funds market than it lends

Answer 1

Solution:

Net Interest Margin = Interest Incomes - Interest expenses / Average Earning assets

1) Increase, Because an Increase in lending rate will increase interest income. Hence higher net interest margin

2) No increase, Because the interest rates on loans are more than interest on treasury notes. Hence if Borrowers paid off their dues interest income will reduce & interest income from treasury bonds will be less than interest on loans

3) Increase, Because Interest expense on demand deposits is less than time deposits. So when demand deposits will rise interest expense will reduce which will increase net interest margin.

4) No increase, Because Idle cash will have no effect on the net interest margin

5) Increase, Because When a bank borrows more from federal funds market, its net interest margin will increase if federal funds decreases interest rates which ultimately leads to reduction in interest expense.