FINANCIAL SECTOR REFORMS
389
on loans,
r
, and the risk associated with loan returns,
, on the two axes as
depicted in Figure 14.3. Bankers are assumed to be risk averse and their
indifference curves are upward sloping in (
r
,
) space. This means that
bankers are willing to assume higher risk provided it is accompanied by a
higher return.
The banks’ asset choice is to select a combination of risky loans from the
loan return frontier and the riskless T-bill asset issued by the government,
which earns a return
r
TB
without fail as it has sovereign backing. The straight
line drawn as a tangent from the point
r
TB
to the ...
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