So you have a business loan approved with your bank but the interest rate you have been offered is very different to your neighbour who has a business loan with them also. Or the bank is being a bit vague on an interest rate for a business loan you are considering. This is pretty well standard across the banking industry when it comes to business loans as banks assess business quite differently to home loans.

Ring any Bank and they can tell you very quickly what their home loan rates are as they are reasonably set and don't vary a great deal. With business loans Banks generally have a Risk Grade Matrix in which we have to answer a number of questions around the financial data provided and around the ability of the person applying for the business loan.

Depending on the bank there could be 10 to 18 questions to be answered before a risk profile rating can be allocated to a client. Some Banks call this a Probability of Default or PD rating.  

An example of some of the categories your Business Banking Manager may need to comment on and rate are Management Skill Level; Management Succession; Working Capital Position; Profit Performance; Industry Risk; Business Outlook. Categories vary from bank to bank as do the grading methods and outcomes, though across the board the better your rating the better the interest rate you will be offered.

The amount of security you offer to the bank also helps to determine your interest rate as the more security we have lessens the risk. Banks will align the PD Rating and security available into a matrix which then provides an interest rate risk margin which is added to the Banks standard base rate.

Basically, the higher the risk, the higher the rate. This is because with a higher risk the Bank's have to put aside more funds to cover your loan in case of default which is a cost to the bank. So this cost is passed on to the customer via their interest rate.

Whilst this is of little comfort to you the customer, the Bank is not making anymore money on the client who is a moderate risk and being charged 6.00% compared to the higher risk client with less security who is being charged 8.00%.