Cost of Funds

Date Added: 05/06/2012 by Mark Ryall - MRM Finance

We have all seen and heard the Reserve Bank drop the cash rate, but what does this mean to me as a commercial borrower. The basic fundamental of a bank is to lend out money to make a profit. They achieve this by borrowing funds from various sources at X and lending out to borrowers at Y. 
When a bank wants to lend out more money than it is has in deposits, it can borrow the money from the wholesale markets which is made up of both short term and long term funds from Australia, New Zealand and offshore capital markets. For the major Australian Banks, the split between deposits and wholesale funding has been around 50 / 50.
Despite what many people think, the official cash rate and the interest rates charged and paid by banks are not directly linked. The official cash rate is the rate the RBA charge for overnight interest and we clearly can't safely run a bank borrowing all our money one day at a time. The official cash rate is just one of the variables that make up the cost of funds for banks. Australia has 1 of the best banking systems in the world due to the tight fiscal monetary policies. We wouldn’t want to have a banking system similar to Greece or other parts of Europe. 

A high percentage of clients will have a loan linked to the money markets which determines the commercial rate on your facility. This type of loan is very fluid and moves in line a lot quicker than the traditional home loan product. When the Reserve Bank decrease the Cash Rates, commercial clients wouldn’t see the same drop in their commercial rate. This is due to the markets factoring in upcoming decreases separate to the Reserve Bank announcements. This is reflected on the commercial cash rates before the official cash rate decreased. 

The interest rate that you pay to the bank is determined by some of the following factors:

Type of Industry
Experience of the operator
Type of Security
Length of tenure

The financier uses some of the above criteria to establish the interest rate for your commercial loans along with the cost of funds. 


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