Question

How does drawing on a line of credit affect the banks’ assets and alter the banks’ liabilities?

Answer 1

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In following ways drawing on a line of credit affect the banks’ assets and alter the banks’ liabilities

Line of Credit (LOC)

A line of credit (LOC) is a preset borrowing limit that can be used at any time. The borrower can take money out as needed until the limit is reached, and as money is repaid, it can be borrowed again in the case of an open line of credit.

A LOC is an arrangement between a financial institution—usually a bank—and a client that establishes the maximum loan amount the customer can borrow. The borrower can access funds from the line of credit at any time as long as they do not exceed the maximum amount (or credit limit) set in the agreement and meet any other requirements such as making timely minimum payments. It may be offered as a facility.

Function of Line of Credit

• A line of credit has built-in flexibility, which is its main advantage.
• Unlike a closed-end credit account, a line of credit is an open-end credit account, which allows borrowers to spend the money, repay it, and spend it again in a never-ending cycle.
• While a credit line’s main advantage is flexibility, potential downsides include high-interest rates, severe penalties for late payments, and the potential to overspend.

Affect on Banks assets and banks liabilities

All LOCs consist of a set amount of money that can be borrowed as needed, paid back and borrowed again. The amount of interest, size of payments, and other rules are set by the lender. - These are assets lead to profit

Some lines of credit allow you to write checks (drafts) while others include a type of credit or debit card. As noted above, a LOC can be secured (by collateral) or unsecured, with unsecured LOCs typically subject to higher interest rates.- These to lead to buid long term assets

A line of credit has built-in flexibility, which is its main advantage. Borrowers can request a certain amount, but they do not have to use it all. Rather, they can tailor their spending on the LOC to their needs and owe interest only on the amount they draw, not on the entire credit line. In addition, borrowers can adjust their repayment amounts as needed, based on their budget or cash flow. They can repay, for example, the entire outstanding balance all at once or just make the minimum monthly payments.- It is the main primary function to create assets

Limitations of Lines of Credit

The main advantage of a line of credit is the ability to borrow only the amount needed and avoid paying interest on a large loan. That said, borrowers need to be aware of potential problems when taking out a line of credit.

• Unsecured LOCs have higher interest rates and credit requirements than those secured by collateral.
• Interest rates (APRs) for lines of credit are almost always variable and vary widely from one lender to another.
• Lines of credit do not provide the same regulatory protection as credit cards. Penalties for late-payments and going over the LOC limit can be severe.
• An open line of credit can invite overspending, leading to an inability to make payments.
• Misuse of a line of credit can hurt a borrower’s credit score.

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