Interest—reference rates and margin

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

  • Interest—reference rates and margin
  • Cost of lending
  • Fixed rate or floating rate?
  • Fixed rates
  • Floating rates
  • How floating rates are calculated
  • Components of a floating interest rate—reference rate
  • Sterling Overnight Index Average (SONIA)
  • London Interbank Offered Rate (LIBOR)
  • Reference rate floors and zero floors
  • More...

Interest—reference rates and margin

One way for banks and other financial institutions to generate revenue is by charging interest on the loans they make.

This Practice Note explains:

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

  2. the differences between fixed and floating rates of interest

  3. how floating interest rates are calculated, including information on SONIA and LIBOR

  4. what is meant by reference rate floors and zero floors, and

  5. what is meant by 'default interest' and when it might constitute a penalty

This Practice Note does not discuss interest provisions in loan documentation in detail. For information on interest provisions in LMA facility documentation that is based on risk-free rates such as compounded or term Sterling Overnight Index Average (SONIA), see Practice Note: Interest provisions in risk-free rate based loan agreements. For information about interest provisions in Loan Market Association (LMA) facility documentation which is based on the London Interbank Offered Rate (LIBOR), see Practice Note: Interest provisions in (LIBOR-based) Loan Market Association (LMA) documentation [Archived].

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.

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

  1. money deposited by customers or raised from other investors (eg

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