ncrease, as was the case in the late 1970’s, the consumer gets a higher rate on their deposits but the interest paid to the bank on loans remains the same. This results in a lower spread between the deposits and the loans. If interest rates go down the opposite occurs. Interest rates on commercial loans are different than consumer loans as they are set at a variable rate. This reduces the banks risk in terms of interest rate movement. Therefore, commercial loans are preferred over consumer loans.EXAMPLE:YEAR 1YEAR 2YEAR 3YEAR 4YEAR 5Rate=10%Rate=12%Rate=14%Rate=16%Rate=18%VariableDEPOSIT $10$11$12.32$14.04$16.29$19.22Set for 5 yrsLEND$10$11.2$12.54$14.04$15.73$17.62Rate=12%Rate=12%Rate=12%Rate=12%Rate=12%As you can see in the following example: As interest rates increase the margin between Deposits and Loans get smaller, eventually the margin becomes negative and the financial institution starts loosing money.As stated earlier, commercial loan lending rates are variable and are not exposed to this interest risk. APPENDIX DKEY OPERATIONAL AND FINANCIAL FACTS FOR PELHAM: Recorded losses of increasing amounts from 1978 to 1981; by 1981 the annual losses were in excess of 1.1 million. Their spreads were smaller than Niagara’s: 1.87% of total assets at Pelham vs. 2.68 at Niagara. Large data processing costs and non-interest expenses. Poor matching of maturities, even by credit union standards. In general Pelham’s poor financial position negatively affects Niagara’s capital base and financial flexibility. APPENDIX EBREAKDOWN OF NIAGARA’S COMERCIAL LOANS:Niagara’s total assets: $ 155,704Business & Farm Loans (commercial loans):$11,647,000Business & Farm Loans / Assets: = 11,647,000/155,704,000 = 7.48% Other Loans: $17,846Business, Farm Loans and Other Loans / Assets: = 29,493,000/155,704,000= 18.9% (exceeds 15% cap)Assuming half “other loans” a...
