Suppose Delta Bank enters into a number of long-term commercial and retail loans at fixed rate prevailing at the time the loans are originated.

Suppose Delta Bank enters into a number of long-term commercial and retail loans at fixed rate prevailing at the time the loans are originated.

If the interest rates rise:
A . The bank will have to pay higher interest rates to its depositors and would have to pay higher rates on its debt to the extent the debt interest rate was linked to floating indices, or to the extent the debt used to fund the loans was of a shorter maturity than the loans.
B . The bank will have to pay higher interest rates to its depositors and would have to pay lower rates on its debt to the extent the debt interest rate was linked to floating indices, or to the extent the debt used to fund the loans was of a shorter maturity than the loans.
C . The bank will have to pay lower interest rates to its depositors and would have to pay higher rates on its debt to the extent the debt interest rate was linked to floating indices, or to the extent the debt used to fund the loans was of a shorter maturity than the loans.
D . The bank will have to pay lower interest rates to its depositors and would have to pay lower rates on its debt to the extent the debt interest rate was linked to floating indices, or to the extent the debt used to
fund the loans was of a shorter maturity than the loans.

View Answer

Answer: A

Explanation:

When a bank enters into long-term fixed-rate loans and interest rates rise, the bank faces higher costs for its deposits and debt if these are linked to floating rates or have shorter maturities. This creates a mismatch between the fixed income from the loans and the increased cost of funds, potentially squeezing the bank’s margins.