Banks using a risk based pricing approach, charge interest rates on loans to cover:

• The cost of borrowing or funding

• Expected cost of loan default

• Expenses to service the client

• A rate of return on capital employed

Different banks will potentially charge different interest rates to the same client.  The differences depend on the banks’ source of funds, the rate of return required and level of capital employed.  Of course, differences in the banks’ strategies or in their view of the client’s default risk will also result in different rates being offered.

On the other hand, the investors approach to pricing assets is different.  Typically an investor would discount the cash flows at a rate built up as follows:

• Risk free rate

• Expected cost of loan default

• Risk premium

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