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The 3 C's of Bank Margins

As CFO it is likely you have negotiated a bank lending margin or two. Often these meetings are less of a negotiation and more being told the bank’s terms. The experience can leave a sour taste when your legitimate questions are ignored, over complicated or explained away with generalised market commentary and unsubstantiated anecdotal market feedback.

When receiving news of your bank lending margin, it seldom aligns with your expectations or intuition.

In all probability the only time you have received a material reduction in lending margins was as a result of a tender or refinancing. And anyone who has run this process for a business of scale will agree it is disruptive, time consuming and a painful exercise to switch banks.

You could be forgiven for thinking your bank margins behave in a counter-cyclical irrational fashion and generally increase until serious talk about refinancing occurs.

What you think will decrease your margin:
  • Improved EBITDA
  • Awareness of improved bank funding markets
  • Increased collateral provided
What you are told is increasing your margin:
  • ‘Unquestionable strong’ CET1 & TLAC regulatory changes
  • Volatile and uncertain credit markets
  • Global wholesale funding markets

How do all those regulatory acronyms like ‘CET1’ and ‘TLAC’ or concepts  ‘unquestionably strong’ actually impact your margin? 

What Determines your Margin?

Lending margins are based on solid risk principles and financial mathematical rationale. There is method and fairness in their theoretical determination.

The unfairness comes where the lack of market transparency hinders price discovery and combines with unrestrained profit KPIs to achieve ‘bank super profits’ for personal, divisional and shareholder gain. This is entirely predictable and as financial executives would be hypocritical if we were to judge these ‘for profit’ entities making the best profits they can.

Understanding the 3C’s that determine your lending margin will give you an advantage in your next negotiation.

Introducing BankEdge – Margin Reviews & Negotiation

BankEdge provides an alternative to tenders or refinancing, where margin negotiations can be based on substantiated data insights into the bank-pricing market. Education on pricing mechanisms and data transparency elevate the conversation away from refinancing ultimatums to an informed two-way negotiation. Below we share the ‘Three C’s determining your Bank Margins’.

The 3 C’s determining your lending margin


Banks must hold capital in proportion against everything considered a ‘risky asset’. For simplicity we will assume that capital refers to shareholder equity capital also known as “Common Equity Tier 1” or CET1.

Your company’s loan (your liability) is the bank’s asset, and there is a risk that some or all the loan is not repaid. Capital acts as a buffer to absorb any unexpected losses and ensure that deposit providers are protected. Shareholders require a return on their equity capital, and hence capital is considered ‘expensive’ relative to other funding.

All else being equal, an increase in regulatory capital requirements translates to more capital set aside for your lending. This will mean an increase to your margins, or more accurately, your limit or line fee portion of your total margins.

Higher capital requirements


Higher capital requirements

Source: RBA Financial Stability Review October 2020

Cost of Funds

A bank is a financial intermediary. Your bank must first borrow funds to on-lend to your company. The cost of this action is known as the cost of funds. Typically cost-of-funding is synonymous with cost of term wholesale funding. The bankers at the negotiating table would be happy with this confusion as term wholesale funding is expensive relative to other sources of funds and provides for some pretty charts and confusing market jargon. Term wholesale funding costs are still well below shareholder capital costs, but well above the marginal cost for additional customer deposit funding. 

A better understanding of the cost of funds is to consider the approximate blend of bank funding;  

  • ~8% Capital 
  • 6065% customer deposits  
  • ~14% short term wholesale funding 
  • ~16% long term wholesale funding  

The RBA recently did some superb data crunching on this here. 

Currently, the RBA’s Term Funding Facility (TFF) is providing all wholesale term funding at near 0% cost. 

For the customer deposit funding component, the banks are also awash with deposits with rates also at or near 0%. However, here in lies a conundrum – when the RBA cash rate was 2-4%, banks offering 0% on a transactional (non-interest bearing) account were collecting a ‘funding benefit’ of 200-400bpts. The net result being this loss of funding benefit is an upward margin pressure. 

Cost of funds


blended cost of all forms of funding


lower wholesale funding costs


margin reduction

However, offset by

Cash Rate 0.10%

lost of funding benefit


upward margin pressure

Source: RBA Developments in Banks’ Funding Costs and Lending Rates

Source: RBA Developments in Banks’ Funding Costs and Lending Rates

Credit Worthiness

The final C relates to your company’s financial performance and financial collateral provided. The basic (but rather difficult to compute) concept is;

  • what is the probability your company can not repay its debts causing default, and
  • in the event of default, what is the potential financial loss to the bank.

The probability factors in quantitative financial measures such as your company financials and forecasts as well as qualitative industry, competition and management capability overlays.
The loss in event of default relates to the security held by the bank and ranges from fully secured to partially secured to unsecured lending.
These credit measures combine with facility structure variables to determine the amount of capital required for your company’s “risky assets” aka loans and limits.

Stronger financial performance

lower chance of default
less risk capital
lower margin

Increased security

lower loss potential
less risk capital
lower margin
Bank margins should not be viewed as a mystery

Your bank margins need not be viewed as disconnected from business, market and regulatory factors. Margins are driven by risk transfer and financial market pricing principles that can be distilled down into intuitive components that are understandable without a career in banking. 

That’s not to downplay the complexities in the matter. Within the banks entire floors across many office buildings are devoted to these models. And without these teams of bankers dedicated to correctly pricing credit risk and funding costs we would be at the mercy of another financial crisis. 

The challenge is identifying the win-win fair price – that is a profitable deal for bank shareholders whilst simultaneously a fair margin for you, the borrower. 

And for the bankers reading along, you can file this next to your copy of the 4 C’s of Credit Lending 

Daniel Chalmers

About Daniel Chalmers

Dan is the Managing Director at BankEdge. He has a unique end-to-end combination of banking technical valuation skills and client-sales-advisory experience gained over nearly two decades of managing client accounts whilst working in a major Australian bank followed by as an independent banking consultant.

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