Commercial banks are for-profit financial institutions that offer a number of different products and services to consumers and businesses. Many borrowers obtain term loans and revolving debt products from these institutions but commercial bank lending rates are affected by a variety of different factors. Loan default rates, the cost of interbank lending and supply and demand all have an impact on the cost of lending.
Banks review loan applications and use the borrower's income documentation and credit history to estimate the likelihood of the borrower defaulting on a loan. Lenders impose minimum lending standards to ensure that loans are not written for high-risk borrowers but unexpected events such as a job loss or a nationwide recession can cause a previously reliable borrower to default on a debt. Typically, lenders compensate for possible losses when lending rates are established and rates are set at a level so that the lender can remain profitable even if a certain number of borrowers fail to repay their debts. Nevertheless, when defaults rise, lenders adjust rates upward to compensate for lost revenue. Lending rates often rise during severe recessions.
Many nations have central banks and these banks lend money to commercial banks and other lenders. Central banks raise rates to discourage lending when inflation starts to negatively impact the economy. Conversely, central banks lower rates during some recessionary periods as a way of encouraging banks to lend. When rates drop, banks pay less to borrow funds and these savings are sometimes passed onto consumer and business customers in the form of reduced commercial bank lending rates.
Aside from borrowing money from central banks, commercial lenders also raise funds by selling certificates of deposit (CDs) and other interest bearing deposit products. Laws in some areas require banks to keep a certain amount of deposit funds on hand at all times and some banks have to raise CD rates to fend off competition for customers from other banks. If CD rates rise, then commercial bank lending rates also typically rise.
A number of factors such as recessions and central bank lending rates have an impact on lending rates as a whole but other factors can have an impact on the commercial bank lending rates customers pay. A bank may allow someone with poor credit to take out a loan if that individual agrees to pay a higher than average interest rate. Properties in certain regions such as homes in coastal areas are more at risk of sustaining damage from floods and hurricanes. Some banks charge higher interest rates on secured loans if the collateral securing the loan is exposed to an above average risk of incurring damage
