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Monthly Archives: May 2014

Risk based pricing of loans by banks

Introduction

In an earlier post, I talked about how banks set interest rates for loans compared to investors. I would like to explore the bank’s approach over a couple of posts. This post covers one approach to setting the interest rate to charge for a corporate loan.

The interest rate charged is:

  • The cost of borrowing funds
  • Expected cost of loan default
  • Expense margin
  • A rate of return on capital employed

Components of interest rate

Loan price waterfall

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