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The determinants of the lending interest rate in a cost-based approach: Theoretical model and empirical analysis

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  • Amvella Motaze, Serge Patrick

Abstract

We develop a mathematical model to determine the lending interest rate applied by a financial institution in a cost-based approach. Our model mathematically isolates the four main components of the total cost of credit, including net operating costs, weighted average cost of funding, cost of risk and weighted cost of equity. Our equations enable us to determine the floor interest rate, which is the minimum interest rate that a financial institution should set for its credit operations to be profitable. The results of the empirical analyses carried out over a 15-year period, from 2004 to 2018, corroborate the suggestions of our model that interest rates follow the evolution of the floor interest rate. One of the contributions of our model is that the results can be useful in policies that seek to improve the credit conditions of financial institutions by reducing their credit costs rather than imposing low interest rates to them.

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  • Amvella Motaze, Serge Patrick, 2022. "The determinants of the lending interest rate in a cost-based approach: Theoretical model and empirical analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 83(C), pages 36-51.
    • Handle: RePEc:eee:quaeco:v:83:y:2022:i:c:p:36-51
    DOI: 10.1016/j.qref.2021.10.003
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    More about this item

    Keywords

    Interest rates; Credit costs; Financial institutions; Microfinance;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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