What is a bank's cost of funds?

The average interest rate a bank pays on the money it has borrowed — deposits of every kind, bonds, short-term borrowing — weighted by how much of each it holds. On the bank constructed for this page it is 3.09%: US$278m of interest on US$9.0bn of borrowed money. It is the floor under the bank's lending rates, because a loan priced below it loses money before a single cost or bad debt. New loans, though, are priced off the cost of new money for the same term, which is usually above the average, because the cheapest funding is already in use.

Why does a term deposit pay more than a savings account?

Because the bank is buying time. Savings and call money can be withdrawn today; a term deposit generally cannot be withdrawn before it matures without notice or a cost, so the bank can lend it for that term and count on it through a stress. Liquidity rules recognise the difference: the Basel Liquidity Coverage Ratio lets a bank leave out of its thirty-day stressed outflows a retail term deposit with more than thirty days to run that cannot be withdrawn inside that window without a significant penalty. The constructed bank pays a point more for that certainty — US$30m a year on US$3.0bn.

Why do banks borrow from wholesale markets if they have deposits?

For three reasons. Many banks lend more than their customers deposit — the constructed bank has US$8.0bn of loans against US$7.0bn of deposits — and the gap has to be borrowed. Bonds lend the bank money for years, which suits long loans better than deposits repayable today. And bonds that rank behind depositors can count as capital. The price is that wholesale money is dearer — 4.65% on average here, against 2.64% for deposits — and quicker to leave, because its lenders are professionals who reprice together when the bank's standing changes.

What is the core funding ratio?

A New Zealand liquidity rule. The Reserve Bank compares a locally incorporated bank's core funding — funding it can expect to stay in place for at least a year — with its loans and advances, and requires the first to be at least 75% of the second. It cut the minimum to 50% in April 2020, to support lending during the pandemic, and returned it to 75% on 1 January 2022. It sits beside the Basel Committee's Net Stable Funding Ratio, which asks a similar question over the same one-year horizon.

// HOW A BANK WORKSTHE FUNDING SIDE

Where Banks Get Their Money

A bank lends money it has mostly borrowed — from depositors first, from markets for the rest, and from its shareholders underneath both. Here is what each kind costs, how long it stays, and which leaves first when confidence goes.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-03

// THE SHORT ANSWER

A bank funds its loans mostly with borrowed money: customer deposits first, wholesale markets for the rest, and shareholders' equity underneath. On a bank constructed for this page, US$7.0bn of deposits and US$2.0bn of wholesale borrowing cost US$278m a year — a cost of funds of 3.09%, the floor under every lending rate. Everyday accounts are the cheapest and stickiest money; wholesale money is dearer and quicker to leave. Equity pays no interest yet is the dearest of all, because it loses first. A buffer of liquid assets, 21% of deposits here, is the price of lending long against money repayable today.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// WORK THE SUM

Every Groundwork file that is a number to work out — cash conversion, debt service cover, expected loss, risk-weighted assets, the margin on a bank's own book — with the working shown in the senior read. One minute each, no signup.

Open The Number →

// 01 — THE OTHER SIDE OF THE BALANCE SHEET

A bank's balance sheet has two sides. One is what the bank owns, mostly loans. The other is where the money for them came from, and that side is this page. Take a bank constructed for this page — the same one the other pages in this order use — with US$10.0bn of assets, US$8.0bn of them loans, funded like this:

Transaction accounts · US$2.0bn · 0.25% · on demand · many small balances, slow to move as a whole
Savings and call accounts · US$2.0bn · 3.0% · on demand · moves for a better rate; large balances move first
Term deposits · US$3.0bn · 4.0% · until maturity · cannot run; must be won again when it matures
Bonds sold to investors · US$1.5bn · 4.8% · years · cannot run; must be refinanced at the market's price
Short-term borrowing · US$0.5bn · 4.2% · weeks to months · the first to leave
Shareholders' equity · US$1.0bn · no interest · permanent · never leaves, and loses first

Customers have lent the bank US$7.0bn, wholesale markets US$2.0bn, and shareholders have put in US$1.0bn. The bank pays interest on the first two:

Transaction accounts 2,000 × 0.25% = US$5m

Savings and call 2,000 × 3.0% = US$60m

Term deposits 3,000 × 4.0% = US$120m

Bonds 1,500 × 4.8% = US$72m

Short-term borrowing 500 × 4.2% = US$21m

Interest paid US$278m

Cost of borrowed funds = 278 ÷ 9,000 = 3.09%

That last line is the bank's cost of funds: the average price of every borrowed dollar. Equity is left out of it because it pays no interest — which, as section 03 shows, does not make it cheap.

// 02 — THE FLOOR UNDER EVERY LENDING RATE

The constructed bank earns 6.0% on its loans and pays 3.09% for the money it borrowed to make them. A loan priced at 3.09% would earn nothing before the bank had paid a salary or lost a loan. The cost of funds is the floor every lending rate stands on, and everything above it has to pay for running the bank, for the loans that go bad, and for the shareholders.

A new loan, though, is not funded at the average. The average describes money the bank already has, some of it raised years ago at other prices. The next dollar comes from whichever source the bank must add to — usually a term deposit or a bond — at today's price for that term:

Average cost of what the bank already owes 3.09%

Next dollar, from a term deposit 4.0%

Next dollar, from a bond 4.8%

That is why a bank's treasury charges its lending desks for money by term, at the price of new funding rather than the average of old, and why loan rates move when funding markets move even for a borrower who has not changed. How Banks Price a Business Loan builds a margin on top of that charge; How an Interest Rate Change Reaches You follows it back to the central bank.

// 03 — SHAREHOLDERS' MONEY: THE DEAREST, AND THE FIRST TO LOSE

The US$1.0bn the shareholders put in pays no interest, and it is the most expensive money the bank has. Shareholders are paid last, after every depositor and bondholder, and they lose first when loans go bad. Nobody takes that position for 4.8%. Assume — it is an assumption, not a market figure — that the constructed bank's shareholders want 10% a year:

Required return (assumed) 10% × 1,000 = US$100m a year, after tax

Before tax at 28% 100 ÷ (1 − 0.28) = US$139m, or 13.9% of the equity

What the year earned 92.2 ÷ 1,000 = 9.2% return on equity

Interest is paid before tax; a return to shareholders comes out of what is left after it. So a dollar of equity has to earn nearly three times what the bank pays its bondholders before it pays its way. In the year shown, the constructed bank earned 9.2% on its equity, short of the 10% assumed — the gap How to Read a Bank's Results teaches a shareholder to look for.

Why not fund the bank with cheaper debt instead? Because equity absorbs losses before anyone who lent the bank money does, and the capital rules set a minimum of it behind every loan, scaled to the loan's risk — the subject of Risk-Weighted Assets. The same US$1.0bn, seen from the depositor's side, is one of the layers counted in Is My Money Safe in a Bank?

// 04 — YOUR EVERYDAY ACCOUNT, AND WHY A TERM DEPOSIT PAYS MORE

The cheapest money in the constructed bank is the US$2.0bn in transaction accounts at 0.25%. People keep it there to pay and be paid, not to earn interest, so it barely responds to price. Its worth to the bank shows when you price the alternative:

Transaction accounts 2,000 × 0.25% = US$5m

The same money, borrowed short-term 2,000 × 4.2% = US$84m

What the everyday accounts save the bank US$79m a year

Against net interest income of US$250m 79 ÷ 250 = 32%

The saving is not all profit. Those accounts need a payments system, cards, an app and people to answer the phone, and that cost sits inside the bank's US$140m of operating expenses. But it is why banks compete for the everyday account harder than for almost anything else, and why How Banks Work counts transactional balances among the cheapest, stickiest deposits a bank can hold.

A term deposit is the opposite trade. The constructed bank pays 4.0% on its US$3.0bn of term deposits against 3.0% on savings — US$30m a year more (3,000 × 1.0%) — and what it buys is time. Money that cannot simply be withdrawn before it matures can fund a loan for its term, and it stays put through a stress.

The Basel Committee's Liquidity Coverage Ratio, which models a thirty-day stress, puts the order of departure into its assumptions. A fully insured household deposit in a transactional account or an established relationship usually runs off at 5%; a less stable retail deposit at 10% or more; unsecured money lent by other banks and financial institutions at 100%. A retail term deposit with more than thirty days to run, which the depositor cannot withdraw inside the thirty days without a significant penalty, can be left out altogether.

// 05 — WHY A BANK ALSO BORROWS FROM MARKETS

The constructed bank's customers have lent it US$7.0bn, and it has lent out US$8.0bn — a loans-to-deposits ratio of 114%. Add the liquid assets it must hold and the premises and systems it runs on, and deposits and equity together fall short:

Assets to fund 8,000 loans + 1,500 liquid + 500 other = US$10,000m

Deposits and equity 7,000 + 1,000 = US$8,000m

Borrowed from wholesale markets US$2,000m

Average cost: wholesale 93 ÷ 2,000 = 4.65%; deposits 185 ÷ 7,000 = 2.64%

The first reason a bank borrows from markets is that arithmetic: it has lent more than its customers have deposited. The second is term. Deposits are mostly short, while a bond lends the bank money for years — money that can fund a five-year business loan without having to be won again every month. The third is capital. US$0.12bn of the constructed bank's bonds are subordinated: their holders agreed to be repaid after depositors and other creditors, so the bonds count as Tier 2 capital, one more layer between a depositor and a loss.

Wholesale money is also the most mobile. Its lenders are professionals who read the bank's results and the market's mood, and they tend to act together. The short-term borrowing is the first funding to leave when confidence goes. The bonds cannot leave before they mature, but they must be refinanced when they do, at whatever the market asks of this bank that day. A bank that leans on markets has made its funding cost, and sometimes its funding, depend on how it is seen.

SHORT WHOLESALE FUNDING, SIGNAL OR NOISE → · CONCENTRATED DEPOSITS, WHAT THEY HEAR →

// 06 — MATURITY TRANSFORMATION, AND THE BUFFER THAT PAYS FOR IT

Put the two sides together and the shape of banking appears. US$4.0bn of the constructed bank's deposits can be withdrawn today; its home loans run for decades and its business loans for years. Turning short money into long loans — maturity transformation — is the service a bank sells and the risk it carries, because the loans cannot be called in to meet withdrawals. The answer is a buffer of assets the bank can turn into cash at once:

Repayable on demand 2,000 + 2,000 = US$4,000m

Liquid assets 300 reserves + 1,200 high-grade bonds = US$1,500m

Liquid assets ÷ customer deposits 1,500 ÷ 7,000 = 21%

Income given up by holding them instead of lending them

1,500 × (6.0% − 3.2%) = US$42m a year

That US$42m, before the losses a loan would bring, is the price of being able to pay on demand. It is why no bank holds more liquidity than it must, and why no regulator lets it hold less. Two measures in the Basel Committee's framework set the floor. The Liquidity Coverage Ratio asks for enough high-quality liquid assets to meet thirty days of severe stress: the stock must at least equal the stressed net outflows, a ratio no lower than 100% outside a stress, and the standard expects a bank to use the stock when the stress comes. The Net Stable Funding Ratio looks out a year: funding expected to stay reliable over that year must be at least 100% of the stable funding the bank's assets require.

Countries apply their own versions. New Zealand's Reserve Bank sets locally incorporated banks mismatch ratios over one week and one month, which test whether liquid assets cover a stressed gap between cash in and cash out, and a core funding ratio: funding expected to stay for at least a year must equal at least 75% of the bank's loans and advances. The Reserve Bank cut that minimum to 50% in April 2020 to support lending through the pandemic, and returned it to 75% on 1 January 2022. What happens to the constructed bank when depositors do start to leave is worked in the depositor's page.

WORK IT · LIQUIDITY COVERAGE → · NET INTEREST MARGIN →

// STANDARDS THIS SITS BESIDE

The recognised ground this page sits beside. Each was opened and checked when cited; none is a source for the framework itself.

Basel Committee on Banking Supervision, Basel Framework, LCR40 — Cash inflows and outflows (in force 15 December 2019), paragraphs 40.7, 40.13, 40.16 and 40.42 — Over a thirty-day stress, fully insured stable retail deposits usually run off at 5%, less stable retail deposits at a minimum of 10%, and unsecured funding from other financial institutions at 100%; retail term deposits that cannot be withdrawn within thirty days without significant penalty may be excluded — the order of departure in section 04.
Basel Committee on Banking Supervision, Basel Framework, LCR20 — Calculation (in force 15 December 2019), paragraphs 20.1 and 20.5 — The stock of high-quality liquid assets should at least equal thirty days of stressed net cash outflows, with the ratio no lower than 100% outside a stress, and banks may use the stock during one — the buffer in section 06.
Basel Committee on Banking Supervision, Basel Framework, NSF20 — Calculation (in force 15 December 2019), paragraphs 20.1–20.2 — The Net Stable Funding Ratio is available stable funding, reliable over one year, relative to required stable funding, and must be at least 100% on an ongoing basis — section 06.
Reserve Bank of New Zealand, Liquidity policy for banks — Mismatch ratios; Core funding ratio — Links banks' liquidity risk to maturity transformation and sets one-week and one-month mismatch ratios and a minimum core funding ratio of 75%, which was cut to 50% in April 2020 and restored on 1 January 2022 — section 06.

// QUESTIONS PEOPLE ASK

What is a bank's cost of funds?: The average interest rate a bank pays on the money it has borrowed — deposits of every kind, bonds, short-term borrowing — weighted by how much of each it holds. On the bank constructed for this page it is 3.09%: US$278m of interest on US$9.0bn of borrowed money. It is the floor under the bank's lending rates, because a loan priced below it loses money before a single cost or bad debt. New loans, though, are priced off the cost of new money for the same term, which is usually above the average, because the cheapest funding is already in use.
Why does a term deposit pay more than a savings account?: Because the bank is buying time. Savings and call money can be withdrawn today; a term deposit generally cannot be withdrawn before it matures without notice or a cost, so the bank can lend it for that term and count on it through a stress. Liquidity rules recognise the difference: the Basel Liquidity Coverage Ratio lets a bank leave out of its thirty-day stressed outflows a retail term deposit with more than thirty days to run that cannot be withdrawn inside that window without a significant penalty. The constructed bank pays a point more for that certainty — US$30m a year on US$3.0bn.
Why do banks borrow from wholesale markets if they have deposits?: For three reasons. Many banks lend more than their customers deposit — the constructed bank has US$8.0bn of loans against US$7.0bn of deposits — and the gap has to be borrowed. Bonds lend the bank money for years, which suits long loans better than deposits repayable today. And bonds that rank behind depositors can count as capital. The price is that wholesale money is dearer — 4.65% on average here, against 2.64% for deposits — and quicker to leave, because its lenders are professionals who reprice together when the bank's standing changes.
What is the core funding ratio?: A New Zealand liquidity rule. The Reserve Bank compares a locally incorporated bank's core funding — funding it can expect to stay in place for at least a year — with its loans and advances, and requires the first to be at least 75% of the second. It cut the minimum to 50% in April 2020, to support lending during the pandemic, and returned it to 75% on 1 January 2022. It sits beside the Basel Committee's Net Stable Funding Ratio, which asks a similar question over the same one-year horizon.

// WHAT STANDS BETWEEN A DEPOSIT AND A LOSS

The same bank from the depositor's chair: the layers in front of a deposit, in the order they lose, a week in which a tenth of the on-demand money leaves, and what deposit insurance covers.

Read Is My Money Safe in a Bank? →

THE IN-TRAY · ONE MINUTE