In this study, a highly useful and comprehensive survey of the several loan pricing approaches has been discussed. Particular attention has been paid to the most significant and popularly practiced techniques of pricing the prime lending rate. In the process, highly useful illustrative examples have been discussed on how to scientifically compute the marginal cost of funds. Specifically, the present value approach to loan pricing is discussed as a novel and all inclusive model. This method explains as to how to incorporate the benefits of any deposit balances the borrower leaves with the lending bank. Finally, a brief discussion on the various forms of financial intermediation has been presented. This is done with a view to relating the costs of borrowing funds under several forms of financial intermediation.
Bank profitability depends on how the loan prices compare with the costs of funds and operations. Therefore, loan pricing becomes the focal point of planning income and expenses in banks. The recent history of pricing the prime by the public sector banks has revealed that most of the non-priority sector loans of size Rs. 1 cr and above were either prime priced or linked to the Prime Lending Rate (PLR). Therefore, the PLR becomes the barometer of credit market conditions in the economy today. Open market borrowing by companies having higher credit rating has its advantages, though these borrowers do not find banks irrelevant. Borrowers with even higher ratings are motivated to seek a strong credit relationship with banks because such relationships add value to the credit worthiness of the borrowing firms (James, 1987).
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