Surely you have already experienced a low interest rate on your bank savings, but if you take out a loan you can do it at a much higher interest rate. Many people find this to be unfair, and in most people the question arises as to why there is a big difference between loan interest rates and deposit rates.
In order to answer this question, we need to be aware of the operation of banks and the role of interest rates.
Where will the bank get the money?
Banks have money from us to place our savings on bank customers. Without our savings, banks would not be able to operate, they would use that money for their activities. Though they can make money with credit placement and benefit from it, they can only make a loan in a regulated manner, depending on the size of the deposits. So banks are in any case in need of deposits.
The bank pays interest to us in exchange for placing our money with them. With this, they are paying for the money they are holding, and they are encouraging the placement of deposits. The higher the interest rates, the more willing we are to give our money, the more we get it, and it’s better than keeping our money in the shoe box at home. Banks are therefore encouraging higher interest rates with higher interest rates.
The external interest environment
We can see that interest rates are changing. Today, both deposit and loan rates are lower than a few years ago. The external interest environment has a role to play in how much the bank gives interest on our deposits (and how much it asks for loans). The key interest rate is determined by the National Bank of Hungary (this is the central bank interest rate), which is an important economic policy tool in the hands of the central bank and has a significant impact on the market. Also worth mentioning is the interbank borrowing rate called BUBOR , which is used as a reference for defining individual bank offers. The extent of these has an impact on banks’ deposit and lending interest rates, as these interest rates determine how much the market can borrow. Commercial deposit rates are lower, while lending rates are higher.
Operating costs of the bank
There are a lot of costs involved in running a bank. To mention only the top ones: a branch network has to be maintained, employees have to be employed in branches and in the center, IT systems need to be maintained, reserves need to be formed, and to comply with extremely strict financial operating rules. In the case of the bank, alternative costs should be taken into account: as with all market participants in the economy, the bank will always look for the best investment.
The bank can collect the necessary costs for its operation from its customers by providing the services it provides. This can be the case, for example, in account management fees or transaction fees, but can also enforce these costs through interest. Undoubtedly, this is a much more hidden price than when we pay for the purchased products in the store, but ultimately we have to pay the loan for the loan we have purchased.
The bank is responsible for paying the depositors’ money. In today’s modern banking systems, none of the banks works by physically preserving the deposited money, but using it, for example, for lending. As a result, there is much less money at the bank than the total of deposits. (This will never cause a problem with normal operation, but it can also cause a baseless bank panic to be a real problem if customers are storming the bank and wanting to get their money.) The bank will ultimately risk depositors’ money while responsibility is his.
So the bank is rightly expecting a return beyond its operating cost in exchange for its risk. As we are for higher yields, we are only willing to put our money in riskier investment instruments, the bank is with it. There are always bad debtors among debtors who are unable to repay the loan , or with a solution that means unforeseeable conditions for the bank, extra costs. Notwithstanding the guarantee elements (such as KHR or proof of income), it is not possible to predict with certainty who is a trustworthy and who is not a trustworthy debtor, and that anyone can unexpectedly find themselves in a bad financial situation.
Explanation of different deposit and loan rates
Thus, the difference between the loan interest rate and the deposit interest rate is composed of the “price” due to the bank’s operating costs and the priced risk. This is also explained by the fact that there is a difference between different deposit rates and loan rates. In the case of deposit interest rates, the interest payment of a fixed-term deposit at the end of the term will be much higher than the interest on the money held on the current account – because the deposit is a more predictable, stable construction for the bank and therefore encourages it. In the case of loans, the bank asks for a much higher interest rate surcharge for a risky personal loan than for a mortgage loan where it is covered behind the loan.