Credit and Deposit Pricing

Abstract

The deregulation of financial markets in developing countries has changed the operational environment of banks in substantial ways. The high and volatile interest rates that accompanied deregulation have caused firms with excess balances to demand effective cash management services, and required banks to price their loans to reflect the risk inherent in these loans, the shareholders’ demand for a competitive return on equity, and the increased cost of funding. In repressed financial markets the loan pricing system was a simple one that recognized the stable nominal interest rates on deposits and fixed spreads. Although the pricing standards in repressed financial markets (for example, contractual interest rates, fees and compensating balances) continue to be relevant in developing financial markets, these standards are modified and new standards added. The principal objectives of the new pricing standards are to enable banks in developing financial markets to cope with the: (1) increased competition between themselves and non-bank providers of credit, deposit, and other financial products and services; (2) reduced level of customer loyalty; (3) expanded supply of competitively priced saving and borrowing instruments; and (4) urgent need to price the risks inherent in the banks’ lending activities.