4 ms·

I look at it this way: Scenario A: city deposits their funds in a private bank where the funds earn a 1% interest rate. The private bank lends funds at 5% inter

• mmt 8y ago
  > The private bank lends funds at 5% interest Hang on.. is that the rate the bank is lending at, or their yield, including any losses from things like defaults and costs? > the added benefit of total control over its funds. Actually, not quite, because one no longer has control of any funds that were lent out. If a disproportionate number of borrowers all miss a payment during a particular month (even if the don't outright default and catch up next month), the city/bank will have to borrow those funds from the Fed. This can also happen if the city isn't the only depositor and there's a "run" on the bank. That borrowing, short-term though it may be, adds cost, and the rate is (occasionally) variable, unlike, say, many mortgages. The point is, understanding interest rate spread is simple enough, but the reality (especially with fractional-reserve banking, which is another can of worms) is far more complicated. What seems obvious when explained with the simple model isn't actually so.