The key difference between lending rate and borrowing rate is that lending rate is the rate banks and other financial institutions use to lend funds in the form of loans to their customers whereas borrowing rate is the rate at which commercial banks borrow from the central bank or the return they pay as interest on customer deposits. Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. This difference between lending rate borrowing rate is referred to as the ‘net interest margin’.
1. Overview and Key Difference
2. What is Lending Rate
3. What is Borrowing Rate
4. Side by Side Comparison – Lending Rate vs Borrowing Rate
What is Lending Rate?
This is the rate at which banks and other financial institutions lend funds to customers. Banks and financial institutions generally have the freedom to decide the rate at which to lend funds to investors; however, it is decided after considering the below factors.
The banking industry consists of a number of commercial banks and other institutions that offer similar services. Some of them will offer very attractive rates with the intention of obtaining a higher market share. Thus, the lending rates should always be decided par with the rates offered by other competitor banks
Interest Rate Policy
Interest rate policy is decided by the government and is constantly used to affect monetary policy. Thus, the government can influence the lending rate decisions of commercial banks, stipulating reserve requirements
Demand for Loans
If there is a higher demand for loans from customers, banks have the luxury of charging higher lending rates. Demand may be heavily affected by interest rate volatility where customers may be skeptical of borrowing if the interest rates are subjected to frequent changes.
Even though there may be a range within which a lending rate is derived, banks offer different rates to different customers. They offer funds at the lowest rate possible for the most creditworthy customers and this rate is referred to as the ‘prime rate’. The sum borrowed by the customer, credit rating of the customer, the number of years the customer had been with the bank affects the prime rate. It also depends on the amount of down payment that the customer deposit; if a customer puts down a significant down payment, this indicates that possibility of defaulting the loan in the future is less.
What is Borrowing Rate?
When the customers make deposits in a bank this can be explained as customers lending funds to the bank. Banks offer a lower rate to customer deposits than the rate at which they lend funds. Just as in lending rate, competition from other banks plays a key role here since customers usually evaluate various options available and deposit money in banks that offer them a lucrative rate.
Another perspective to borrowing rate is that commercial banks also borrow from the central bank to maintain the minimum reserve requirement specified by the government. The interest rate at which the Federal Reserve lends to banks is higher than borrowing from another bank.
What is the difference between Lending Rate and Borrowing Rate?
Lending Rate vs Borrowing Rate
|Lending rate is the rate banks and other financial institutions use to lend funds in the form of loans to their customers.||Borrowing rate is the rate at which commercial banks borrow from the central bank or the return they pay as interest on customer deposits.|
|Main Deciding Factor|
|Demand for loans is the main deciding factor for the lending rate.||Borrowing rate is mainly decided on the reserve requirements of banks.|
|Profit for the Bank|
|If the banks can charge a higher lending rate it can earn higher profits.||If the borrowing rates are higher this reduces earnings for the banks.|
Summary – Lending Rate vs Borrowing Rate
The difference between lending rate and borrowing rate depends on a number of factors as explained above. Generally, a bank looks to borrow or pay short-term rates to depositors, and lend through making loans at the longer-term to generate a higher yield. If a bank can do this successfully, it will make money and please the shareholders. The Central bank and the government play a major role in deciding the said rates as their actions affect the economy at large.
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2. “Yield Curve.” Investopedia. N.p., 18 Nov. 2003. Web. 19 Mar. 2017.
3. “Prime Rate.” Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail. N.p., n.d. Web. 19 Mar. 2017.
4. “Bonds, Borrowing, and Lending.” Library of Economics and Liberty. N.p., n.d. Web.20 Mar. 2017.
1. “German bank interest rates from 1967 to 2003 grid” By 84user – (Public Domain) via Commons Wikimedia