What it means
A bank or lender does not usually link each loan to one specific source of money. It gathers funds from many places, mixes them together and lends out of the mixture.
The pooled cost of funds is the weighted average cost of that mixture, where each source is weighted by how much money it supplies. The method matters for pricing and for measuring profit.
If the pooled cost is 3.5%, a loan priced at 7% earns a spread (the gap between what the lender charges and what its money costs) of 3.5 percentage points before operating costs and credit losses. Without a common funding rate, different teams could argue endlessly about which loan was funded by which dollar.
Finance teams often use the pooled rate as a transfer price, which is the internal rate that the treasury department charges business units for the money they lend. This keeps lending teams focused on credit decisions and customer margins, while treasury carries the job of managing funding.
It also makes performance comparisons fairer across products and branches. The main alternative is the marginal cost of funds, which is the cost of raising one more dollar today.
When market rates are rising, the marginal cost is usually higher than the pooled cost because older, cheaper funding is still in the mix. Pricing loans off the pooled rate in that situation can leave the lender underpricing new business.
The pooled approach has other limits. It blurs the difference between short-term and long-term funding, and between loans that are quick to repay and those that last years.
Many institutions therefore combine a pooled rate with adjustments for the term and currency of each loan. Small lenders and non-bank finance companies use the same idea.
A firm that funds loans with a bank credit line, investor notes and its own capital can work out a pooled rate across all three, and then set its lending rates with a clear understanding of its breakeven.
In practice
Real-world examples.
Example
A community bank prices a small business loan at 6.5%. The treasury team tells the loan officers that the pooled cost of funds is 2.9%, so the officers know the spread is 3.6% before costs and can see how much room there is to negotiate.
Example
An equipment finance company funds its leases with a bank line at 6% and investor notes at 8%, split 50-50. It calculates a pooled cost of 7% and refuses any lease priced below 9%, because it needs a margin of at least 2 percentage points.
Example
A credit union notices that its pooled cost has risen from 1.8% to 2.4% as cheap savings accounts were replaced with higher-paying term deposits. The finance manager raises loan rates by 0.5 percentage points to protect the margin.
Formula
Calculation
Pooled cost of funds = sum of (amount from each source x its rate) / total funds
Suppose a lender has $100,000,000 of funding made up of $60,000,000 of customer deposits at 2%, $30,000,000 of wholesale borrowing at 5% and $10,000,000 of subordinated debt at 8%.
Deposits cost 60,000,000 x 0.02 = $1,200,000 a year.
Wholesale borrowing costs 30,000,000 x 0.05 = $1,500,000 a year.
Subordinated debt costs 10,000,000 x 0.08 = $800,000 a year.
Total cost = 1,200,000 + 1,500,000 + 800,000 = $3,500,000.
Pooled cost of funds = 3,500,000 / 100,000,000 = 3.5%.
A loan priced at 7% therefore carries a gross spread of 7% - 3.5% = 3.5%, which still has to cover operating costs and expected credit losses.Case study
Seen in the real world.
Kestrel Lending is a fictional consumer finance company with $50,000,000 of funding. In this illustrative scenario, $30,000,000 comes from a bank facility at 4% and $20,000,000 from investor notes at 7%. The pooled cost is (30,000,000 x 0.04 + 20,000,000 x 0.07) / 50,000,000 = (1,200,000 + 1,400,000) / 50,000,000 = 5.2%.
The sales team wants to offer loans at 8% to win market share, which leaves a gross spread of 2.8%. The finance director points out that operating costs run at 1.6% of loans and expected credit losses at 1.5%, so the loan would lose 0.3 percentage points a year.
The company decides to price at 9.5% for riskier borrowers and keep the 8% rate for its safest customers only. It also resolves to update the pooled rate every quarter so pricing keeps up with changes in funding costs.
Watch out
Common mistakes.
- Using the simple average of the rates instead of the weighted average. A tiny funding source at a high rate should not count as much as a huge one at a low rate.
- Forgetting that the pooled rate lags the market. When rates are rising, new funding costs more than the blended figure suggests.
- Treating the spread as profit. Operating costs and credit losses still have to be paid out of it.
Questions
People also ask.
What is the difference between pooled and marginal cost of funds?
Pooled cost is the average across all existing funding, while marginal cost is the price of raising one extra dollar today.
Does equity count in the pool?
Often yes, using the return shareholders expect, though some lenders leave equity out and only pool borrowed money.
How often should it be updated?
Most lenders recalculate it monthly or quarterly, and more often when market rates are moving fast.
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