The cost of raising or mobilizing funds from the market. It is reflected in the interest amounts paid to providers of funds such as savers/ depositors. This cost is calculated by dividing the total interest expense by the average balance of funds over a specific period. For example, if a bank pays $100,000 in interest on deposits and has an average deposit balance of $2 million, the cost of funding is calculated as:
Cost of funding = total cost of funds/ average balance of funds
Cost of funding = 100,000/ 5,000,000
Cost of funding = 2%
The cost of funding (or cost of funds) is the interest rate a bank must pay to mobilize the funds it uses in making loans to its customers. This cost includes the cost of borrowing from depositors, other banks, and the money market. Banks use these funds to extend loans to borrowers, so that to earn interest on the loans made. The difference between the interest earned on loans and the interest paid on deposits and other funding sources is known as the net interest margin (NIM).
