Definition
Cost of Funds
Cost of Funds is the weighted-average interest rate a bank or NBFC pays to raise the money it lends, covering deposits, borrowings and bonds.
For a bank, the cost of funds is driven mainly by the deposit mix. A high CASA ratio lowers it because savings and current account balances pay little or no interest, while term deposits and bulk deposits cost more.
NBFCs and HFCs, which cannot accept demand deposits, depend on bank borrowings, commercial paper and NCDs, so their cost of funds tracks bond-market yields and their own credit rating. A downgrade can sharply raise the cost of funds and compress lending spreads.
Related terms
- Net Interest Margin (NIM)Net Interest Margin is the difference between the interest a bank earns on advances and investments and what it pays on deposits and borrowings, expressed as a percentage of average interest-earning assets.
- Yield on AdvancesYield on Advances is the average interest rate a bank earns on its loan book, calculated as interest income from advances divided by average advances.
- Spread (Banking)In banking, the spread is the difference between the yield a bank earns on its assets and the rate it pays on its liabilities, typically the gap between yield on advances and cost of funds.
- Marginal Cost of FundsMarginal cost of funds is the cost of raising the next rupee of funds, used by the RBI's MCLR framework as the basis for pricing floating-rate bank loans.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.