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Promised Return on a Loan

The contractually promised return (k) is a function of loan features. The numerator is simply promised bank receipts: origination fee (f) plus base lending rate (BR; e.g., LIBOR or something approximating cost of capital) plus margin (m; includes credit risk premium). The denominator includes the compensating balance (b, the portion of loan held on deposit at the bank. As the borrower does not access this portion, it increases the borrower's cost and is an additional source of return to the bank) and the reserve requirement (RR, the Fed requires the bank to hold reserves against the compensating balance. Notice its effect is exactly analogous to the compensating balance)
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