Bank spread

What is a bank spread?

Bank spread is the difference between the interest rate that a bank charges a borrower and the interest rate a bank pays a depositor.

Deeper definition

A financial institution’s bank spread, also referred to as net interest rate spread, is similar to the concept of net income. A bank earns money from interest it receives on loans and other assets, and it pays out money to customers who make financial transactions with the bank, such as depositing money into a savings account.

The bank spread can indicate a bank’s profit margin. A high spread equates to a higher profit margin, since the difference between interest earned and interest paid out is high.

However, bank spread measures the average difference between lending and borrowing interest rates, not the amount of banking activity itself, which means that bank spread doesn’t necessarily indicate a financial institution’s profitability. But it is a key factor.

A bank’s interest rate is determined by rates set by the Federal Reserve, as well as activities in the open market and competition with other banks. Other factors include inflation, national and international demand for money, and stock market activity.

Bank spread example

Consider a bank that lends money to customers at an average rate of 8 percent. At the same time, the interest rate the bank pays on funds that customers deposit into their personal accounts is 1 percent. The net interest spread of that financial institution would be 8 percent minus 1 percent, resulting in a bank spread of 7 percent.

However, during a recession, banks may increase interests rates paid out, and they also may encourage people to take out loans by lowering interest rates offered.

For example, a bank may lower the interest rate on loans to 7.5 percent and increase the interest rate on deposits to 1.5 percent, which would lower the financial institution’s bank spread to 6 percent, and lower its profit margin. But this adjustment may be advantageous for the bank’s long-term profits if it leads to more business.

Interested in learning how to earn back an even higher interest rate on your savings? Opening a certificate of deposit account may be a smart way to manage savings. Here’s a look at how to invest money through a CD.

 

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