Bank economics
Cost of funds
Calculate a balance-weighted cost of funds from deposits and borrowings, and see what a shift in deposit mix costs.
Learning objectives
- Calculate a blended cost of funds weighted by average balances
- Distinguish the cost of interest-bearing liabilities from the cost of total funding
- Estimate how a shift from demand to time deposits changes funding cost and NIM
A bank's raw material is money. Its cost of funds sets the floor under every loan price and drives half of the net interest margin. Two banks lending at the same rate can earn very different margins simply because one funds itself with free current accounts and the other with expensive term deposits and wholesale borrowing.
Treasury teams track the cost of funds every month, and loan officers meet it through the internal funding (transfer) price charged to every new loan.
Cost of funds = Σ (Average balanceᵢ × Rateᵢ) ÷ Σ Average balanceᵢ = Interest expense ÷ Average funding
- i
- each funding source: demand deposits, savings and time deposits, due to banks, term borrowings
- Rateᵢ
- the annual interest rate paid on that source (0% for non-interest-bearing demand deposits)
- Cost of interest-bearing liabilities
- the same ratio over interest-bearing sources only
- Cost of total funding
- includes demand deposits in the denominator, so it is lower
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 3 graded exercises, and every other Finance Quest lesson.