How a bank calculate interest rate?

 

Loan Pricing

Do we know, how a bank calculate interest rate for the borrower. If no, then following is the calculation

1.       Cost of fund= Interest paid/(deposit+borrowing) *100

Cost of fund refers to the cost which is necessary for the fund collection. Mainly bank has two sources for collection fund. 1. Deposit 2. Borrowing

2.       Cost of administration= Non-interest expense/ Loan and advance *100

Cost of administration refers to the cost that incurred for running the administration. Example: Salary, rent.

3.       Cost of capital= expected profit (in terms of percentage) *Equity/ Loan and advances

Cost of capital means return given to the capital providers or owners of the bank. It depends on the opportunity cost of capital necessary to be given to the owners for supplying the fund to the bank. 

4.       Base rate= Cost of fund + Cost of administration + Cost of capital

BBank can not charge below the base rate. This is the minimum rate, a bank can charge from the borrower.

5.       Risk premium: Risk premium is given based on the category of borrower. Risk premium refers to additional charge applied for the risky borrowers. In other word, bank will charge less interest for trustworthy borrowers, whereas a little bit higher interest will be charged for the relatively risky borrowers. Bank does not take any premium from “Excellent borrower”

6.   Margin: international standard is 1%. The amount what will be going to the banks’ pocket or amount that has been kept for the bank.

Loan pricing = Base rate + risk premium + Margin