What it is
A bank's raw material is money, and money has a price: the interest it pays depositors and lenders. Cost of funds is that price as an average percentage.
If a bank holds Rs 100 arba of deposits and borrowings and pays Rs 6 arba of interest a year, its cost of funds is 6%.
It is the first ingredient of the base rate, and the bank's lending rates sit on top of it. A low cost of funds lets a bank lend cheaper and still earn a margin.
How it is calculated
Cost of funds (%) = Interest expense (annualised) ÷ Average interest-bearing liabilities (deposits + borrowings + debentures) × 100.
Worked on Nabil Bank Limited, FY 2082/83 Q4
NABIL's cost of funds was 3.09% for FY 2082/83, with interest expense of Rs 2,094.61 crore on deposits of about Rs 59,255.94 crore.
What good looks like
Lower than peers, and stable. The lowest-cost banks have the largest share of savings and current deposits. Cost of funds rises after rate hikes with a lag as fixed deposits reprice.
Watch out
- A falling cost of funds across all banks reflects market rates, not skill; compare against peers.
- The figure is annualised in quarterly reports.
- Cheap interbank or NRB refinance can flatter it temporarily.
In Nepal
Cost of funds is the first component of NRB's base rate formula (cost of fund + CRR cost + SLR cost + operating cost + 0.75% return on assets, per NRB's 2012 base rate directive as reported). Both cost of funds and base rate appear in the quarterly ratio schedule.
Questions
They hold more savings and current accounts, which pay little or no interest, and fewer high-rate fixed deposits.
Usually. The base rate is built on it, and loans are priced at base rate plus a premium.