How do I calculate cost of funds for a bank?

Divide the bank's total interest expense by its average interest-bearing liabilities. The result is an annualized percentage that represents the average rate the bank pays across all its funding sources, including deposits, borrowings, and debt.

The formula for cost of funds is:

Cost of Funds = Total Interest Expense / Average Interest-Bearing Liabilities

The result is an annualized percentage. If a bank's cost of funds is 2.00%, it pays two cents per year for every dollar of interest-bearing funding on its books.

Step-by-Step Calculation

1. Find total interest expense on the income statement. This captures everything the bank pays to its funding sources:

Interest paid on deposits (savings, money market, certificates of deposit, interest-bearing checking)

Interest on short-term borrowings (federal funds purchased, repurchase agreements)

Interest on long-term debt (Federal Home Loan Bank, or FHLB, advances, subordinated notes, senior unsecured debt)

Interest on any other interest-bearing liabilities

2. Find total interest-bearing liabilities on the balance sheet. These are the balances that generate those interest expense line items: interest-bearing deposits, fed funds purchased, repurchase agreements, FHLB advances, subordinated debt, and other borrowings. Do not include non-interest-bearing deposits.

3. Calculate the average interest-bearing liabilities by adding the beginning-of-period balance to the end-of-period balance and dividing by two. If monthly or daily average balance data is available, use that for a more precise figure.

4. Divide total interest expense by average interest-bearing liabilities.

Worked Example

Consider a mid-size regional bank with total interest expense of $120 million for the year. Its interest-bearing liabilities stood at $5.8 billion at the start of the year and $6.2 billion at year-end, giving an average of $6.0 billion.

Cost of Funds = $120M / $6.0B = 2.00%

That 2.00% means the bank paid an average of two cents per year for every dollar of interest-bearing funding. If you compare this bank to peers, the number gains meaning in context. A competitor with cost of funds at 1.70% has a 30-basis-point funding advantage that flows directly into its net interest margin.

Annualizing Quarterly Figures

If you're working from a single quarter's data, multiply the quarterly interest expense by four before dividing by the quarterly average interest-bearing liabilities. A bank reporting $32 million of interest expense in Q2 with quarterly average interest-bearing liabilities of $6.0 billion would have an annualized cost of funds of ($32M x 4) / $6.0B = 2.13%.

A more precise approach uses the trailing twelve months (TTM) of interest expense divided by the average of five consecutive quarter-end balances of interest-bearing liabilities. TTM smooths out seasonal fluctuations and avoids the distortion a single unusual quarter can introduce.

Cost of Funds vs. Cost of Deposits

These two metrics are related but cover different ground. Cost of deposits uses only deposit-related interest expense in the numerator and only average deposits (or average interest-bearing deposits) in the denominator. Cost of funds is broader because it captures all interest-bearing liabilities, including non-deposit borrowings.

When cost of funds runs noticeably above cost of deposits, the gap signals that the bank relies on wholesale or institutional borrowings carrying higher rates than its deposit base. A bank with cost of deposits at 1.50% and cost of funds at 2.10%, for example, is paying a 60-basis-point premium on its non-deposit funding. That spread is worth monitoring because non-deposit borrowings tend to reprice faster and can compress margins during rate volatility.

The All-In Calculation

Some analysts calculate a blended "all-in" cost of funds by dividing total interest expense by average total funding, where total funding equals interest-bearing liabilities plus non-interest-bearing deposits. This produces a lower number because non-interest-bearing deposits increase the denominator without adding any interest expense to the numerator.

The all-in version highlights the value of a bank's non-interest-bearing deposit base. A bank sitting on $2 billion in non-interest-bearing checking accounts gets significant free funding that pulls its blended cost well below the standard metric. This version is less commonly reported but can be especially useful when comparing banks with very different proportions of non-interest-bearing deposits.

Interpreting the Result

The absolute level of cost of funds shifts with the interest rate environment, so the number itself matters less than how it compares to peers and how it trends over time. A bank consistently funding itself more cheaply than competitors has a structural advantage that compounds quarter after quarter through wider net interest margins.

A few benchmarks to consider:

Banks with strong core deposit franchises (high proportions of checking and savings from retail and small business customers) typically sit at the low end of peer cost of funds

Banks relying heavily on time deposits, brokered certificates of deposit (CDs), or FHLB advances tend to sit at the higher end

The spread between a bank's cost of funds and its yield on earning assets is a rough proxy for net interest spread, which drives most of a bank's revenue

A rising cost of funds is not automatically a problem. If asset yields are rising faster, the net spread widens and profitability improves. The concern arises when cost of funds climbs while asset yields stay flat or lag behind, squeezing net interest margin (NIM). Tracking both sides of the spread over several quarters reveals whether the bank's funding position is strengthening or deteriorating.

Differences Across Bank Types

Community banks often carry a cost-of-funds advantage rooted in local deposit relationships. Their customers tend to be less rate-sensitive, which keeps deposit costs lower. But community banks with limited deposit-gathering capacity sometimes turn to FHLB advances or brokered CDs to fund loan growth, and those borrowings push cost of funds higher.

Larger regional and national banks have more diverse funding options (commercial paper, medium-term notes, securitization) but also face more rate-competitive depositors. A large bank's institutional and treasury management clients move money quickly when rates rise, which can push deposit repricing faster than at smaller institutions.

Banks with significant trust or wealth management operations sometimes benefit from large custodial deposit balances that carry low or zero interest costs. These balances pull overall cost of funds below what the bank's deposit rate sheet alone would suggest.

Common Calculation Mistakes

A few errors come up regularly:

Including non-interest-bearing deposits in the denominator without intending to calculate the all-in version. This produces a lower number and creates misleading comparisons to peers using the standard formula.

Forgetting to annualize quarterly data. Dividing one quarter's interest expense by average liabilities gives you a quarterly rate, not an annual one. Always multiply by four or use TTM figures.

Using end-of-period liabilities instead of the average. If a bank added $500 million in FHLB advances in December, the year-end balance overstates the liabilities that were actually generating interest expense for most of the year.

Mixing up cost of funds with cost of deposits when comparing across banks. These are different metrics with different denominators, and using one formula for some banks and the other for the rest invalidates the comparison.

Where to Find the Inputs

Total interest expense is on the income statement, typically broken out into interest on deposits, interest on borrowings, and interest on subordinated debt. Interest-bearing liabilities appear on the balance sheet.

Most banks provide more granular breakdowns in the notes to financial statements. The interest rate sensitivity table in the 10-K is especially useful because it often lists average balances and average rates paid by liability category. That table lets you see not just the overall cost of funds but what each funding component is contributing to the total.