Banks are structured and operate differently. However, the loan Interest Rate charged by a bank is determined by two characteristics, namely bank-specific characteristics and customer-specific characteristics..
- Bank Specific Characteristics (Cost of Funds & Margins)
- Banks will price loans based on their Cost of Funds. This is a cost that is influenced by both wholesale deposits and deposits from individual bank customers (also known as retail deposits).
- The wholesale deposit rates significantly influence the loan interest rate. For example, corporations typically require a high interest rate to be paid for the deposit they keep with a bank; the bank therefore will price most of its loans based on that wholesale deposit, plus margin to cover the bank''s operational costs, risk and return to shareholders (profit margin).
- Customer Specific Characteristics (Risk Profile & Product Specifications)
- Just as banks are different, so are customers. When issuing a loan, banks will assess a customer based on that customer''s ability to repay the loan. This is called the "risk profile" of the customer. There is a price associated with the likelihood that the customer will repay the loan, or the likelihood of default.
- To determine the customer''s profile, a bank will use a Credit Report provided by a licenced Credit Reference Bureau. The Credit Report covers the customer''s Credit History (an account of debt obligations and repayment track record).
- There are also different product types. Depending on the product, there would be a cost associated with the risk the bank would take by selling the product. For example, an unsecured loan carries a higher risk than a loan secured by an asset (collateral).