Loan pricing means determining the interest rate for granting a loan to creditors, be it individuals or business firms. It is one of the most important, however difficult tasks in lending funds to business firms & other customers. It is the procedure of determining the interest rate for granting a loan, naturally as an interest spread (margin) over the base rate. Because it is always very difficult to exactly know what the actual loan risk a particular loan application is. A bank acquires funds through deposits, borrowings, antiquity recognizing the costs of each source and the resulting average cost of funds to the bank. The price of the loan is the interest rate the borrowers must pay to the bank, in addition to the amount borrowed (principal).
Generally, the lender wants to charge a high enough rate to make sure that the loan will be profitable as well as it will cover enough compensation against the default risk. On the other hand loan price must be set low enough that helps the customers to find it easy for successful repayment of a loan. The overall advantage of effective loan pricing is that it is one of the many ways a financial institution can optimize capital.