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FINANCIAL LAW SEMINAR FOR JUDGES HOW BANKS CALCULATE INTEREST RATES jnketsiah/01/12/11.

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Presentation on theme: "FINANCIAL LAW SEMINAR FOR JUDGES HOW BANKS CALCULATE INTEREST RATES jnketsiah/01/12/11."— Presentation transcript:

1 FINANCIAL LAW SEMINAR FOR JUDGES HOW BANKS CALCULATE INTEREST RATES jnketsiah/01/12/11

2 INTEREST RATES Interest is the price paid by a borrower for the use of money that is borrowed from a lender. It is expressed as a percentage of the amount borrowed; hence the term interest rate. Interest rate is the amount of interest expressed as a percentage of the amount borrowed jnketsiah/01/12/11

3 NOMINAL VERSUS REAL Nominal interest rate is the actual interest paid expressed as a percentage of the amount borrowed. If a borrower pays interest of GHC10 on GHC100 borrowed for one year the nominal interest rate is 10% Real interest rate is a measure of the purchasing power of interest receipt jnketsiah/01/12/11

4 NOMINAL VERSUS REAL Real interest rate is calculated by adjusting the nominal interest rate by inflation. If a borrower pays interest of GHC10 on GHC100 borrowed for one year when annual inflation rate is 8%, the real interest rate is 2%; i.e 10% minus 8% jnketsiah/01/12/11

5 DETERMINATION OF LENDING RATES The key drivers of a banks lending rates are: The banks base rate; The industry of the borrower The borrowers specific risk jnketsiah/01/12/11

6 BASE RATE It is the rate that banks lend to their prime (first class) customers; The main variables in a banks base rate are: Cost of funds Operating expenses Loan loss provision Profit margin/shareholders return jnketsiah/01/12/11

7 COST OF FUNDS DepositAmountWeight (%)Cost (%)Adjusted*WACF Demand Savings Fixed1, Borrowing Total2, *Primary reserve of 9%, cash ratio of 6% jnketsiah/01/12/11

8 OPERATING EXPENSES The operating expenses of a bank consist of: Personnel cost Occupancy cost Technology cost Administration cost jnketsiah/01/12/11

9 OVERHEADS ABSORPTION RATE Example: A banks total asset is GHC2100 million Operational expenses is GHC80 million. Earning Assets ratio is 70% Overheads absorption rate is 80/(2100X70%) multiply by 100 (80/1470) X 100 = 5.44% jnketsiah/01/12/11

10 LOAN LOSS PROVISION The Regulator requires Banks to make provision for loan losses according to the classification and formula below: Current 1% OLEM10% Sub standard25% Doubtful50% Loss10% jnketsiah/01/12/11

11 LOAN LOSS PROVISION CLASSIFICATIONBALANCEREQUIREDPREVIOUSCHARGE Current1, OLEM Sub standard Doudtful (20) Loss50 0 Total1, Loan Loss Provision rate = (62/1,470) X % jnketsiah/01/12/11

12 BASE RATE Granted that a banks profit margin on loans is 2.5% the base rate of the bank becomes Cost of Funds8.50% Operational expenses5.44% Loan loss provision4.22% Profit margin2.50% Base Rate20.66% jnketsiah/01/12/11


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