Benchmark interest rate pricing method is a loan pricing method that selects an appropriate benchmark interest rate, and the bank adds a certain spread or multiplies it by an addition coefficient.
The benchmark interest rate can be short-term treasury bill rate, large negotiable deposit certificate interest rate, interbank lending rate, commercial paper interest rate and other money market interest rates. It can also be the preferential loan interest rate, that is, the lowest interest rate for banks to issue short-term working capital loans to high-quality customers. Because these financial instruments or loan contracts are characterized by low default risk,
Therefore, their interest rate is usually called RisklessInterestRate, which is a common pricing reference system in financial markets, so it is also called benchmark interest rate. For selected customers, banks often allow customers to choose the benchmark interest rate for the corresponding period as the pricing basis, and the additional loan risk premium level varies with the customer's risk level.
According to the basic principle of benchmark interest rate pricing method, the interest rate formula of bank loans to specific customers is generally:
Loan interest rate = benchmark interest rate+borrower default risk premium+long-term loan term risk premium.
The latter two parts of the formula are the price increase based on the benchmark interest rate. A variety of risk adjustment methods can be used to set the default risk premium, which is usually determined according to the risk level of the loan. However, for high-risk customers, banks do not simply charge a higher risk premium, because doing so will only increase the default risk of loans. Therefore, in the face of high-risk customers, banks mostly follow the idea of credit rationing and refuse such loan applications to avoid risks. If the loan term is long, the bank needs to add a term risk premium.
Before 1970s, when western banks used the benchmark interest rate pricing method, they generally used the preferential interest rate of big banks as the benchmark for loan pricing.
In 1970s, due to the internationalization of the banking industry, the dominant position of preferential interest rate as the benchmark interest rate of commercial loans was challenged by LIBOR, and many banks began to use LIBOR as the benchmark interest rate. LIBOR provides a unified price standard for banks in various countries and a benchmark for customers to compare bank loan interest rates.
After 1980s, there appeared a loan pricing model below the benchmark interest rate.