Useful Knowledge learn in Banking Management Subject:

My Week 1 Lecture class:

Interest rates is define as the "price" that lenders charge for lending their money to borrowers. Reflecting a form of compensating to the lender.
Reference: http://www.finpipe.com/intcomp.htm

There is 1 formula on how to calculate the interest rate from the bank.
which is

K = K* + IP + MRP + LP + DRP

Where by:
K = Interest rate
K* = Desire profit of the bank.
IP = Inflation Premium
LP = Liquidity Premium
DRP = Default Risk Premium

K*
- Which indicate how much money the bank actually want to earn when the borrow loan to others.
- The bank can set it according to their wish.

IP = Inflation premium
- Because of inflation, the purchasing power will be drop due to the Time Value Money(TVM), then the bank will charge customer from now.
(eg. today you can get a pen at RM 1.20 but for the next year, when you want to get the same pen, you might need to pay RM 2.00 for the same pen. --> inflation occur)
- Therefore, the bank will charge customer inside the interest rate they offer for the customer.

MRP = Maturity Risk Premium
- For example, 1 year loan, every month the customer pay the bank interest to bank and bank know that they will make money from you. But, suddenly the customer say that, he or she could pay back the loan within 6 months. Therefore, te income for another 6 month for the bank has gone. So, the bank will charge the customer first.

LP = Liquidity Premium.
- Example, the bank think/expect, What if after 1 year,all of sudden, the bank will face difficulty to buy thing with this money?
- Therefore, this is the risk of liquidity problem.
- The bank had foresee today, then the bank will charge the customer now.

DRP = Default Risk Premium
- The expectation from the bank for the customer unable to pay back the loan.
- For example, Assume the customer unable to pay the debt at at 6th month. Therefore, the bank will charge the customer for the expected loss.

[Unfair practice:
- When the customer unable to pay the loan.
The bank had charge the penalty for the late payment.
If the customer unable to meet the debt for 3 month continuously, the bank have the right to take the customer assets. (eg. car, house)
If the customer want to repay back, the customer need to pay back more and more.( Interest + Interest)]

[The bank already include the default risk premium inside the interest rates, why they still charge us for penalty? Take customer's assets? --> unfair.]