Why does Cost of Funds matter for bank investors?

A lower Cost of Funds means cheaper funding, which directly supports wider net interest margins and higher profitability. A bank paying less for its funding earns a better spread on every loan and investment it makes. To see this in practice: a bank with a Cost of Funds of 2.5% and loan yields of 6.0% earns a gross interest spread of 3.5%. A competitor with a Cost of Funds of 1.8% and the same 6.0% loan yield earns a 4.2% spread, giving it 70 basis points more margin to absorb credit losses, cover operating expenses, and generate profit. Several factors shape a bank's Cost of Funds: The prevailing interest rate environment, since higher rates generally push funding costs up The bank's deposit mix, particularly the proportion of low-cost and non-interest-bearing accounts Reliance on wholesale funding versus core deposits Competitive conditions in the bank's local deposit markets Management's deposit pricing strategy and willingness to pay up for growth Because these factors vary widely, Cost of Funds is most useful when compared to peers of similar size and geographic footprint rather than evaluated against an absolute standard. Key consideration: Cost of Funds excludes non-interest-bearing deposits from the denominator, which means two banks with the same Cost of Funds can have very different total funding costs. To capture the full benefit of free funding, some analysts calculate "total cost of deposits" by dividing interest expense on deposits by total deposits (including non-interest-bearing accounts). This adjusted figure reflects the blended cost of the entire deposit franchise and provides a more complete picture of funding efficiency.

What metrics are related to Cost of Funds?

Cost of Funds is commonly analyzed alongside Cost of Deposits, Net Interest Margin (NIM), Deposits to Assets Ratio, Loans to Deposits Ratio, Interest Income to Average Earning Assets, Return on Average Assets (ROAA). Together, these metrics provide a more complete picture of a bank's financial health and help investors make informed comparisons.

Cost of Funds

Q: How is Cost of Funds calculated for banks?

The formula is: Cost of Funds = Total Interest Expense / Average Interest-Bearing Liabilities. The numerator is total interest expense from the income statement. This includes interest paid on deposits, borrowings, subordinated debt, and any other interest-bearing liabilities. It captures every dollar of interest the bank paid during the period, regardless of the funding source. The denominator is average interest-bearing liabilities for the period. Non-interest-bearing deposits are excluded from this calculation because they carry no explicit interest cost. This distinction matters: Cost of Funds measures the rate paid only on liabilities that actually carry an interest obligation. Some analysts use total liabilities (including non-interest-bearing deposits) in the denominator to calculate a "total cost of funding" metric instead. This alternative produces a lower number because the denominator is larger, and it captures the benefit of free funding that a bank receives from its non-interest-bearing deposit base. Both versions are useful, but they answer slightly different questions about a bank's funding efficiency. This metric is calculated using data from SEC EDGAR filings, including 10-K and 10-Q reports.

Category: Efficiency & Funding Ratio

Overview

Cost of Funds shows what a bank pays, on average, to get the money it lends out and invests. Banks get their money from depositors, from borrowing from other financial institutions, and from issuing debt. Each of these sources has an interest cost, and Cost of Funds rolls them all into a single average rate.

The calculation divides total interest expense by average interest-bearing liabilities. This produces a percentage representing what the bank pays for each dollar of interest-bearing funding on its balance sheet. The funding components include interest-bearing deposits (savings accounts, money market accounts, certificates of deposit), borrowed funds (Federal Home Loan Bank advances, repurchase agreements, federal funds purchased), and subordinated debt.

Cost of Funds feeds directly into net interest margin (NIM) because it represents the expense side of the spread equation. When a bank earns 5.5% on its loans but pays 2.5% for its funding, the 3.0% difference is the gross interest spread. Keeping Cost of Funds low relative to asset yields is one of the most direct ways a bank supports profitability.

Formula

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

Result is typically expressed as a percentage.

The numerator is total interest expense from the income statement. This includes interest paid on deposits, borrowings, subordinated debt, and any other interest-bearing liabilities. It captures every dollar of interest the bank paid during the period, regardless of the funding source.

The denominator is average interest-bearing liabilities for the period. Non-interest-bearing deposits are excluded from this calculation because they carry no explicit interest cost. This distinction matters: Cost of Funds measures the rate paid only on liabilities that actually carry an interest obligation.

Some analysts use total liabilities (including non-interest-bearing deposits) in the denominator to calculate a "total cost of funding" metric instead. This alternative produces a lower number because the denominator is larger, and it captures the benefit of free funding that a bank receives from its non-interest-bearing deposit base. Both versions are useful, but they answer slightly different questions about a bank's funding efficiency.

Interpretation

A lower Cost of Funds means cheaper funding, which directly supports wider net interest margins and higher profitability. A bank paying less for its funding earns a better spread on every loan and investment it makes.

To see this in practice: a bank with a Cost of Funds of 2.5% and loan yields of 6.0% earns a gross interest spread of 3.5%. A competitor with a Cost of Funds of 1.8% and the same 6.0% loan yield earns a 4.2% spread, giving it 70 basis points more margin to absorb credit losses, cover operating expenses, and generate profit.

Several factors shape a bank's Cost of Funds:

The prevailing interest rate environment, since higher rates generally push funding costs up

The bank's deposit mix, particularly the proportion of low-cost and non-interest-bearing accounts

Reliance on wholesale funding versus core deposits

Competitive conditions in the bank's local deposit markets

Management's deposit pricing strategy and willingness to pay up for growth

Because these factors vary widely, Cost of Funds is most useful when compared to peers of similar size and geographic footprint rather than evaluated against an absolute standard.

Typical Range for Banks

Cost of Funds moves with the interest rate cycle, so any typical range depends entirely on where rates stand. During periods of near-zero short-term rates, many banks report Cost of Funds below 0.50%, with some falling as low as 0.15% to 0.25%. When the federal funds rate rises to 4% or higher, bank Cost of Funds commonly reaches 2.0% to 4.0% or more.

The relationship between the federal funds rate and bank Cost of Funds is positive but not one-to-one. Banks with strong core deposit franchises experience less pass-through of rate increases to their funding costs. A bank with a large base of non-interest-bearing checking accounts and stable savings deposits might see its Cost of Funds rise by only 40 to 60 basis points for every 100-basis-point increase in the fed funds rate. A bank reliant on rate-sensitive CDs and wholesale funding might see nearly the full increase pass through.

This difference in rate sensitivity is one reason peer comparisons matter more than absolute levels. Two banks can have identical Cost of Funds in a low-rate environment but diverge significantly when rates rise, revealing fundamental differences in franchise quality.

Generally Favorable

Cost of Funds below the peer median signals a funding advantage that directly flows to the bottom line. Banks that achieve persistently low Cost of Funds typically share several characteristics:

A high proportion of non-interest-bearing deposits relative to total funding

Stable, relationship-driven core deposit accounts that reprice slowly

Limited dependence on wholesale borrowings or brokered deposits

Strong local market position that reduces the need to compete aggressively on deposit rates

This low-cost funding advantage is one of the most durable competitive strengths in banking. Unlike loan yields, which are largely set by market forces and credit risk, funding costs reflect the depth and quality of a bank's customer relationships. A bank with a structural Cost of Funds advantage carries a wider margin on every dollar of earning assets, giving it more room to absorb credit losses and invest in growth.

Potential Concern

Cost of Funds above the peer median points to expensive funding that squeezes margins. Banks with elevated Cost of Funds often depend heavily on rate-sensitive certificates of deposit, brokered deposits, or wholesale borrowings like Federal Home Loan Bank advances. These funding sources reprice quickly when rates change, leaving less room for margin stability.

A high and rising Cost of Funds can compress net interest margin even when loan yields are also climbing, if funding costs increase faster than asset yields. This is particularly concerning when the increase reflects a bank-specific problem (such as deposit attrition or growing reliance on wholesale funding) rather than an industry-wide rate environment shift.

Watch for patterns where Cost of Funds rises faster than peers over multiple quarters. This can indicate weakening deposit franchise quality, loss of market share in core deposits, or management decisions to pursue aggressive balance sheet growth funded by expensive wholesale sources.

Important Considerations

Cost of Funds excludes non-interest-bearing deposits from the denominator, which means two banks with the same Cost of Funds can have very different total funding costs. To capture the full benefit of free funding, some analysts calculate "total cost of deposits" by dividing interest expense on deposits by total deposits (including non-interest-bearing accounts). This adjusted figure reflects the blended cost of the entire deposit franchise and provides a more complete picture of funding efficiency.
Deposit beta (the percentage of a rate increase that passes through to deposit rates) varies significantly by account type. Non-interest-bearing deposits have zero beta by definition. Savings and money market accounts typically carry low betas of 20-40%. Certificates of deposit have high betas, often 80-100%, because they reprice at maturity to current market rates. A bank's overall deposit mix determines its aggregate beta and how sensitive its Cost of Funds is to changes in the rate environment.
Wholesale funding such as FHLB advances, brokered deposits, and repurchase agreements typically costs more than core deposits but offers flexibility for balance sheet growth. When a bank's Cost of Funds is rising, the first question to ask is whether the increase reflects the broader rate environment (affecting all banks) or a shift toward more expensive funding sources (specific to that bank). The former is cyclical; the latter may signal a deteriorating deposit franchise.
Cost of Funds should always be evaluated alongside asset yields. A bank may deliberately accept higher funding costs if it earns proportionally higher returns on its assets. The interest rate spread (asset yield minus Cost of Funds) matters more than Cost of Funds in isolation. A bank with 4.0% Cost of Funds and 8.0% asset yields generates a wider spread than one with 2.0% Cost of Funds and 5.0% asset yields.
Comparing Cost of Funds across time periods requires awareness of the interest rate cycle. A bank's Cost of Funds rising from 1.0% to 3.0% during a period of Federal Reserve tightening may actually represent strong performance if peers experienced even larger increases. Trend analysis is most meaningful when viewed relative to the fed funds rate or peer group averages rather than as an absolute number.

Related Metrics

Cost of Deposits — Cost of Deposits focuses specifically on the deposit portion of funding, while Cost of Funds includes all interest-bearing liabilities.
Net Interest Margin (NIM) — NIM is the net result of asset yields minus funding costs; Cost of Funds directly determines the expense side of NIM.
Deposits to Assets Ratio — A higher deposits-to-assets ratio generally indicates more stable, potentially lower-cost funding compared to wholesale alternatives.
Loans to Deposits Ratio — Banks with high loans-to-deposits ratios may need to supplement deposits with more expensive wholesale funding, raising Cost of Funds.
Interest Income to Average Earning Assets — Interest income yield minus Cost of Funds approximates the net interest spread, which is a close relative of NIM.
Return on Average Assets (ROAA) — Lower Cost of Funds supports wider NIM, which directly contributes to higher ROAA.

Bank-Specific Context

A bank's Cost of Funds reflects the quality of its deposit franchise, which is one of the most durable competitive advantages in the industry. Unlike many financial metrics that shift quickly with management decisions or market conditions, a low-cost deposit base is built over years through customer relationships, branch network positioning, and sustained market presence.

Deposit Franchise Value

Banks with deep customer relationships, established branch networks in attractive markets, and high proportions of non-interest-bearing and low-rate deposits enjoy a structural funding advantage that directly supports profitability through every rate cycle. This advantage is often referred to as "deposit franchise value" or "core deposit premium" and is a major factor in bank valuations and acquisition pricing. Acquirers routinely pay premiums for banks with low-cost, stable deposit bases because those deposits generate value for decades.

Rate Cycle Performance

During rising rate environments, the gap between banks with strong deposit franchises and those reliant on rate-sensitive funding becomes most visible. A bank with a large non-interest-bearing deposit base and sticky savings accounts might see its Cost of Funds rise modestly, while a bank funded primarily through CDs and wholesale sources faces rapid cost increases. This divergence in funding cost trajectories explains much of the difference in earnings performance across banks during tightening cycles.

Metric Connections

Cost of Funds is one half of the net interest margin (NIM) equation. NIM roughly equals the yield on earning assets minus the cost of interest-bearing liabilities, adjusted for the proportion of free funding from non-interest-bearing deposits and equity. The net interest spread (asset yield minus Cost of Funds) plus the benefit of free funding equals NIM.

To see this connection in concrete terms: if a bank earns 5.5% on earning assets, pays 3.0% on interest-bearing liabilities, and funds 20% of its assets with non-interest-bearing sources, the net interest spread is 2.5%, but NIM will be higher because a portion of earning assets is funded at zero cost.

Cost of Funds also connects to the efficiency ratio indirectly. Banks with higher funding costs need to generate more gross revenue to cover both interest and non-interest expenses, which pushes the efficiency ratio higher. A structural funding cost disadvantage makes it harder to achieve peer-level efficiency even with disciplined expense management.

Common Pitfalls

The most common mistake is comparing Cost of Funds across banks without accounting for differences in non-interest-bearing deposit proportions. A bank with 40% non-interest-bearing deposits and a 3.0% Cost of Funds on interest-bearing liabilities has a much lower total funding cost than a bank with 10% non-interest-bearing deposits and the same 3.0% Cost of Funds. Looking at Cost of Funds alone misses the substantial benefit of free funding.

To make fair comparisons, calculate the "total cost of funding" by dividing total interest expense by total liabilities (or total deposits, including non-interest-bearing accounts). This figure captures the blended cost of all funding, including the zero-cost portion, and provides a more complete basis for peer comparison.

Another pitfall is reading too much into quarter-to-quarter changes. Short-term movements in Cost of Funds often reflect CD maturity timing, seasonal borrowing patterns, or one-time wholesale funding transactions rather than fundamental shifts in the deposit base. Look at the trend over several quarters and compare the trajectory to peers before drawing conclusions about franchise quality.

Across Bank Types

Community Banks

Community banks in rural or less competitive markets often achieve the lowest Cost of Funds in the industry. Their advantage comes from stable, relationship-driven deposit franchises where customers maintain accounts for years or decades. Many community banks carry 25-35% of total deposits in non-interest-bearing accounts, and their savings and money market rates tend to be lower than what larger competitors offer because convenience and personal service reduce customer rate sensitivity.

Regional and Mid-Size Banks

Regional banks face more competitive deposit markets, particularly in metropolitan areas where multiple institutions compete for the same customers. These banks typically need to offer more competitive rates on savings and CD products, which pushes Cost of Funds higher. However, well-positioned regional banks with strong brand recognition and established branch networks can still maintain below-peer funding costs.

Large Banks and Wholesale-Funded Institutions

Large banks in competitive urban markets face the most rate-sensitive deposit customers and also compete against money market mutual funds, online banks, and fintech platforms for deposits. Their Cost of Funds may run higher, though the largest banks offset this somewhat through massive scale in transaction accounts. Banks that rely on wholesale funding (FHLB advances, brokered deposits) for a significant portion of their balance sheet typically carry the highest and most volatile Cost of Funds across all bank types.

What Drives This Metric

Interest Rate Environment

The federal funds rate and broader Treasury rate curve are the dominant external forces on Cost of Funds. When the Federal Reserve raises short-term rates, bank funding costs rise as deposits reprice and wholesale borrowing rates increase. When rates fall, Cost of Funds declines, though typically with a lag as existing CDs and term borrowings mature at their older, higher rates before repricing lower.

Deposit Mix

The composition of a bank's deposit base has the single largest impact on its Cost of Funds relative to peers. Banks with higher proportions of non-interest-bearing checking accounts and low-rate savings deposits pay less for funding than banks dependent on certificates of deposit or money market accounts. A shift in deposit mix toward more rate-sensitive products, even without rate increases from the Fed, will push Cost of Funds higher.

Competitive and Strategic Factors

Local market competition, the presence of online banks and fintech alternatives, and management's deposit pricing strategy all influence where a bank's Cost of Funds lands relative to peers. Some banks deliberately price deposits aggressively to fund loan growth, accepting higher Cost of Funds in exchange for faster balance sheet expansion. Others prioritize margin preservation and accept slower deposit growth. Reliance on wholesale funding sources also factors in, with banks that supplement deposits through FHLB advances or brokered deposits bearing higher and more rate-volatile funding costs.

Related Valuation Methods

Peer Comparison Analysis — Peer comparison analysis highlights differences in funding costs across similar banks, making Cost of Funds one of the most revealing metrics for identifying competitive advantages in deposit gathering.
Discounted Earnings Model — A bank's Cost of Funds directly affects net interest income projections, which form the foundation of discounted earnings valuations. Lower funding costs translate to higher projected earnings.

Frequently Asked Questions

What is cost of funds and how does it differ from cost of deposits?

Cost of Funds measures the average rate paid on all interest-bearing liabilities, while Cost of Deposits focuses only on the deposit portion. Both are key drivers of net interest margin. Read more →

What causes net interest margin to increase or decrease?

NIM is driven by the spread between asset yields and funding costs, making Cost of Funds a direct determinant of margin performance. Read more →

Where to Find This Data

Total interest expense is reported on the income statement in 10-Q and 10-K filings as well as Call Reports (FFIEC 031/041). Most banks break out interest expense by funding type (deposits, short-term borrowings, long-term debt, subordinated notes), which allows you to see where funding costs are concentrated.

Average interest-bearing liabilities can be found in the average balance sheet tables that most banks publish in their quarterly earnings releases and annual 10-K filings. These tables typically show average balances alongside average rates paid, making the Cost of Funds calculation straightforward.

The FFIEC Uniform Bank Performance Report (UBPR) reports cost of funds with peer group comparisons built in, which is especially useful for benchmarking community banks. The FDIC Quarterly Banking Profile publishes aggregate funding cost data for the banking industry organized by asset size group.