[Economic Term] Spread

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Today's economic term is Spread.

The interest rate added to the base interest rate according to conditions such as credit rating is called spread. In other words, it refers to the risk-weighted interest rate added to the base interest rate when setting interest rates for loans, etc. Therefore, if the credit rating is high and the risk is low, the spread will be low. Conversely, if the credit rating is low and the risk is high, the spread will be high.

The main items that make up a spread are:

• Risk premium: difference between funding interest rate and lending standard interest rate, etc.
• Liquidity premium: liquidity risk management costs due to uncertainty in refinancing, etc.
• Credit premium: Average expected loss cost, etc. depending on customer's credit rating, type of collateral, etc.
• Cost of capital: Opportunity cost of necessary capital to be held in preparation for unexpected losses, etc.
• Business costs: Bank labor costs, computer processing costs, etc. depending on loan handling
• Legal expenses: Various taxes such as guarantee agency contribution fees and education tax
• Expected profit rate: The rate of return set by the bank to secure expected profits
• Adjustment interest rate for pre-payment: interest rate for secondary transactions, interest rate for pre-payment adjustment by bank headquarters/branch managers, etc.

Although there is no internationally recognized data comparing the spread by country, the approximate spread level between countries can be compared by comparing the Net Interest Margin (NIM)*, one of the profitability indicators of banks by country.

• (Interest income - Interest expense)/Interest earning assets

[Net interest margin trends of Korean and U.S. banks]

If you look at the chart above, you can estimate that the spread level of Korean banks is considerably lower than that of American banks.

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