Factors that determine loan and deposit pricing
1.Anticipated Inflation
When financial institutions determine the deposit and loan rates offered to customers, consideration is given to the potential inflation rate anticipated in the future. Higher the expected inflation higher will be the interest in deposit & loan and vice-versa.
2.Demand for loan and supply of fund
Demand for loan is one of the determinant of loan pricing. Higher the demand of loan by the customer higher will be the interest rate in loan and vice-versa. And higher the supply of fund as deposit lower will be the interest on deposit and vice versa.
3.The Competition
If there is only one bank for lending and deposit, it is very common that the bank will pay less on the deposit and charge more on the loans. And if there are more bank then there will be the competition among the bank which reduces the loan price and increase the deposit price.
4.Risk of Default
Lending involves the default risk. It is the risk of repayment, i.e., the possibility that an obligor will fail to perform as agreed, causing loss to the lender. By evaluating level of default risk, a bank my charge high interest rate on high default risky lending and low for lower risky lending.
5.Transaction cost:
The bank may charge high interest rate in loan if there is high transaction cost. Transaction costs includes information gathering & processing cost, cost of making legal document, screening and monitoring cost etc.