Whether in conversation or in the news, the spread or margin associated with home loans is a word you hear often. But what does it really mean? Come find out!
What is the bank spread?
The main business of banks is lending money, but in order to do this they need to finance themselves by raising funds, which can be deposits from their customers, or else loans obtained from central banks or other commercial banks.
These financial resources that banks obtain have to be remunerated, whether it is deposits from their customers or loans from other banks. To this cost of obtaining funds, banks add a profit margin when providing financing to their customers, also known as a spread..
The banking spread thus incorporates the profit margin that banks intend to obtain by exercising their financing activity, but not only. The spread also incorporates the risk perceived by banks in relation to their clients, when granting loans, but also possible discounts for contracting other financial products associated with home loans. Therefore, the spread is not the same for everyone.
The impact of credit risk on the spread
The spread is calibrated by assessing the clients’ credit risk on an individual basis for each specific case. Essentially, the bank takes into account not only the customer’s income and its stability over time, but also the quality of the guarantee, obtained by evaluating the property associated with the mortgage, and the relationship between the value of the guarantee and the amount of the loan. The incorporation of these 3 components in the bank’s risk analysis results in a possible expected loss associated with a given loan contract, which serves to adjust the profit margin.
The impact of cross-selling on the spread
However, and because banks are not only in the business of providing financing, it is possible to obtain spread reductions by contracting other banking products and services. For example, it is common for the spread to be adjusted downward when there is the opening of a current account, the hiring of debit and credit cards, joining the electronic banking, the domiciliation of income, the hiring of insurance or even financial applications. These cross-sales of products provide additional profitability, allowing banks to reduce the spread they offer to their customers.
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