Interest—funding rates and margin
Interest—funding rates and margin

The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:

  • Interest—funding rates and margin
  • Cost of lending
  • Fixed rate or floating rate?
  • How floating rates are calculated
  • Components of a floating interest rate—LIBOR (the London Inter-bank Offered Rate)
  • Other inter-bank borrowing rates
  • Replacing LIBOR
  • Components of a floating interest rate—margin
  • Components of a floating interest rate—mandatory costs
  • Default interest—principles
  • more

One way for banks and other financial institutions to generate revenue is by charging interest on the loans they make. For a bank or financial institution to make money through its lending activities, the interest it charges must exceed the costs it incurs in lending the funds.

This Practice Note explains:

  1. what is meant by a bank's 'cost of lending'

  2. how floating interest rates are calculated, and

  3. what is meant by 'default interest'

In this Practice Note, banks and other financial institutions which lend money are referred to generically as 'banks'. In the syndicated loan market, entities other than banks are often involved in lending, so the term 'lenders' is commonly used.

For information about interest provisions in Loan Market Association (LMA) facility documentation, see Practice Note: Interest provisions in Loan Market Association (LMA) documentation.

Cost of lending

Banks incur costs when they lend to borrowers. When a bank decides to lend it will want to make sure it charges sufficient interest to cover its own costs otherwise it will not make any money on the loan.

A bank's costs depend on where it gets its funds from. Principally, banks access funds from two sources:

  1. money deposited by customers or raised from other investors (eg through bond issues)—this is commonly the relevant source of funds for small or short-term loans, or

  2. money