[Learning from AI] How do banks decide interest rates for loans?

Simply put, the policy interest rate is the interest rate that the Bank of Japan adjusts for monetary policy purposes.

When the policy interest rate rises, the environment for banks to procure funds also changes. That impact gradually spreads to the borrowing interest rates for companies and individuals.

BOJ policy interest rate ↓
Bank funding environment
↓
Bank base rate
↓
Lending rate to companies
↓
Interest paid by companies
is the flow. *However, it is not a simple mechanism where “because the policy interest rate rose by 0.5%, the corporate borrowing rate will definitely rise by 0.5%.” This is the key point.

There are several ways to determine interest rates for corporate loans from banks. Typical examples include

1. Short-term prime rate (Short Prime)
2. TIBOR (Tokyo Interbank Offered Rate), etc. In addition, for long-term loans, there are cases where market interest rates are used as a benchmark.

It is called the “Short Prime.” Simply put, it is

the benchmark interest rate when a bank lends money to high-quality companies for the short term. For example, suppose the

“short-term prime rate is 2.125%.”
If the bank adds
0.5% to that, considering the company’s creditworthiness,
it becomes 2.125% + 0.5% = 2.625%.

If you borrow 100 million yen, the interest is 100 million yen x 2.625% = 2,625,000 yen per year.

*Actual interest calculation varies depending on the repayment method, number of days, etc.

Simply put, TIBOR is
an indicator based on the market interest rate when banks lend and borrow money among themselves. This is also sometimes used as a benchmark interest rate for corporate loans. For example, if the

6-month TIBOR is 1.0%
and the bank adds 1.0% to that for the company,
then 1.0% + 1.0% = 2.0%

becomes the borrowing interest rate. If it is 100 million yen, 100 million yen x 2.0% = 2 million yen per year.

To put it very simply, the difference is:
Short Prime = Benchmark rate set by the bank side; TIBOR = Benchmark based on interbank rates formed in the market.

Therefore, even if the same company borrows the same amount, the way the interest rate moves can change depending on which rate is used as the benchmark.

This is also surprisingly important.

Depending on the bank, they may charge a loan fee when providing a loan.

On the other hand, there are also loans that do not charge a fee and instead reflect that cost in the interest rate.

🗒️For example, let’s say you borrow 100 million yen 🗒️
(Bank A)
Interest rate: 2.5%
Loan fee: 0 yen
The annual interest is
100 million yen × 2.5% = 2.5 million yen.
⸻
(Bank B)
Interest rate: 2.0%
Loan fee: 1%
The loan fee is
100 million yen × 1% = 1 million yen.
The annual interest is
100 million yen × 2.0% = 2 million yen.

At first glance, you would think,
“Bank B has a lower interest rate! It’s a better deal!”
.

But you paid a 1 million yen fee upfront.

So, which one is the better deal?
It depends on the loan period.

If you borrow for only 1 year, in simple terms:
(Bank A)
2.5 million yen
⸻
(Bank B)
2 million yen + 1 million yen
= 3 million yen

, so Bank A is cheaper.

But if you borrow for 10 years, then:
(Bank A)
2.5 million yen × 10 years
= 25 million yen
⸻
(Bank B)
2 million yen × 10 years + 1 million yen
= 21 million yen.

In this simple example, the longer you borrow, the more advantageous Bank B becomes.

In other words,
“lower interest rate = always cheaper” is not necessarily true.

When you hear that “the policy interest rate has risen!”
, instead of simply thinking “the borrowing interest rate will go up”, it is important to first check whether your company’s borrowing is
・a fixed interest rate or
・a variable interest rate
, and if it is a variable interest rate, whether it is
・linked to the short-term prime rate or
・linked to market interest rates such as TIBOR
. Furthermore, you should also check

・how much the loan handling fee is
・whether there are other costs such as guarantee fees.

Ultimately, the “borrowing cost” borne by a company is not just the interest rate.When a company borrows money from a bank, it is tempting to think

“the interest rate is 2.0%, so the annual cost is 2.0%”. But in reality, you need to consider

base interest rate
+ bank’s additional interest rate + loan handling fee
+ guarantee fees, etc.
. Therefore, when comparing bank loans, it is important not to just look at “what the interest rate is,” but to look at how much you will end up paying in total.
“what the interest rate is,” but to look at how much you will end up paying in total

to look at.

🗒️To connect this story into one flow:
The Bank of Japan changes the policy interest rate
↓
The bank’s funding environment changes
↓
It affects interest rates such as the short-term prime rate and TIBOR
↓
The company’s borrowing interest rate may change
↓
The interest paid by the company increases or decreases
↓
Furthermore, loan handling fees and guarantee fees also become a burden on the company
. The “policy interest rate” number we see in the news feels distant to us. But when a company borrows hundreds of millions of yen from a bank,

“policy interest rate” a change in interest rate of just 0.1% or 0.5% can result in a difference of hundreds of thousands or millions of yen per year.
a change in interest rate of just 0.1% or 0.5% can result in a difference of hundreds of thousands or millions of yen per year.
Thinking about it that way, interest rate news feels a little more relevant.