Some of the main factors determining loan and deposit pricing are briefly described below:
1.Anticipated Inflation
Anticipated, also termed as expected, inflation is considered as one of the major factor while determining loan and deposit pricing. At the time of determining loan and deposit rates or prices financial institutions consider 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 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. Similarly, higher the supply of fund as deposit, lower will be the interest on deposit and vice versa.
3. Competition in the market
If there is only one bank for lending and deposit, it is very common that the bank will pay less on your deposit and charge more while providing loans. And if there are more bank then there will be the competition among the bank which will reduce the loan price and increase the deposit price.
4. Risk of Default
Lending involves the default risk. It is the risk of not getting back the payment (interest amount and/or principal amount) on time i.e., the possibility that an obligatory will fail to perform as agreed causing loss to the lender. By evaluating level of default risk, bank charges interest accordingly. A bank my charge high interest rate on loan having high default risk and vice-versa.
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.
6. Central Bank Policies (Monetary policy) and Directions:
The bank and other financial institutions should also consider the directions of the central bank while setting up their deposit and loan price. The central bank determines the base interest and the financial institutions should set their prices accordingly.