How are commercial loan rates determined?

In Europe, bank loans remain the leading source of business financing. When they grant credit to the latter, the banks are free to decide on the rate and the amount of the fees to be applied. Regarding the credit rate, the establishments set it by taking into consideration several criteria. Which ? To find out, it is important to know how banking brands work.

Banking establishments sometimes have to refinance themselves and turn to the central bank of their country. Either they do so directly with the institution, or they go through it to borrow from other banks.

In the first case, brands must pledge assets if they want to obtain the requested funds. In the second case, they borrow from their counterparts at the interbank rate.

Set by the central bank, it is derived from the institution’s key rate. Concerning the banks which display a surplus of liquidity, they have the possibility of lending this surplus or placing it at the central bank, on their deposit account.

The constraints to which banks are subject

Still in the course of carrying out their activities, banks must comply with certain constraints. First, they are obliged to maintain a level of compulsory reserves in an account opened with the central bank. This is determined according to the amount of deposits made by their customers.

Next, institutions’ balance sheets must show “eligible” assets to benefit from central bank refinancing. their solvency.

The elements used when setting the credit rate

When granting a loan to businesses, banks set the professional loan rate according to several elements. These include in particular:

  • their refinancing rate
  • the history of the existing relationship with the customer
  • the presence or absence of guarantees (deposit, pledge or counter-guarantee issued by third parties)

It should be noted that lending institutions also charge a margin which is assessed according to the estimated risk . Moreover, for some time now, an unprecedented situation has been observed in the European banking sector. To revive the economy, the key rate and the deposit rate have fallen into negative territory.

As a result, institutions bear a cost on the cash deposited with them that is not immediately lent. In addition, the European Central Bank’s unconventional “quantitative easing” policy has caused interest rates to fall further, which are now historically low, or even negative.

How is the interest rate charged by banks determined?

Banks take several factors into account:

  • the cost of refinancing, i.e. the price at which they buy the money on the financial markets,
  • operating costs,
  • the risk premium.

Added to this, of course, is the profit margin that the banks wish to achieve.

It is naturally the cost of refinancing which constitutes the main cost for the banks and which essentially explains the evolutions in the rates of mortgages. In general, the cost of refinancing is of two types:

  • for fixed-rate loans, the long-term loan, the reference of which is entitled 10-year OAT,
  • for variable rate loans, the short-term loan, the benchmark for which is called Euribor (usually three months or one year).

The overall margins added by the banks to these rates are between 0.50% and 1.50% for an adjustable rate. The fact of having a high personal contribution (for example greater than 25%) allows banks to reduce their risk premium and therefore to offer a more attractive rate.

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