What do commitment fees on an RCF compensate banks for?

What do commitment fees on an RCF compensate banks for?

• A. the cost of capital tied up in the unused facility.
• B. equity allocated to fund the RCF.
• C. for hedging interest rate risk.
• D. for mandatory repayments.

Answer: (B)

Commitment fees on a revolving credit facility are charged on the portion that isn’t drawn to compensate the bank for keeping funds available and for the commitment risk. When a bank agrees to provide a line of credit, it ties up capital and forgoes other investment opportunities, even if the borrower doesn’t actually draw on the facility. The fee rewards the bank for that undrawn capital and for the ongoing obligation to stand ready to lend. It is not about funding equity, hedging interest rate risk, or mandatory repayments, which are governed by other terms of the loan and the drawn amounts. So the best explanation is that the fee represents the cost of capital tied up in the unused portion of the facility.

Commitment fees on a revolving credit facility are charged on the portion that isn’t drawn to compensate the bank for keeping funds available and for the commitment risk. When a bank agrees to provide a line of credit, it ties up capital and forgoes other investment opportunities, even if the borrower doesn’t actually draw on the facility. The fee rewards the bank for that undrawn capital and for the ongoing obligation to stand ready to lend. It is not about funding equity, hedging interest rate risk, or mandatory repayments, which are governed by other terms of the loan and the drawn amounts. So the best explanation is that the fee represents the cost of capital tied up in the unused portion of the facility.