Refinancing –
the key facts at a glance

Key facts at a glance:

• Refinancing is the external procurement of funds for lending.

• To do so, the bank takes out a loan from another bank or on the capital market.

• Refinancing has a significant influence on the terms of lending.

What Is Refinancing?

Refinancing occurs when a financier externally procures the funds for lending — that is, borrows them. A bank, for example, takes out a loan from another bank or on the capital market in order to be able to grant a loan to one of its customers.

Like many terms in finance, "refinancing" is not infrequently confused or conflated with other technical terms. However, in its precise meaning, refinancing is not related to loan restructuring or the repayment of existing loans.

Why Do Banks Borrow Money?

A financier must itself be liquid in order to help a company achieve greater liquidity through a loan. However, if the lender does not have sufficient funds of its own to serve its borrowers, it must procure these from an external source.

In refinancing, various resources can be drawn upon: the long-term deposits of its own customers, loans from the European Central Bank (ECB) or from commercial banks, as well as funds from the sale of its own bonds.

The most economically favourable forms are drawing on in-house savings deposits or the ECB. This is because when a bank takes out a loan from another bank, it must — like any "ordinary" bank customer — pay interest and fees. If the money comes from its own depositors' savings, no interest is payable at all. If lenders borrow the funds from a commercial bank or issue bonds to refinance lending operations, this is often expensive and uneconomical for the institutions. High interest rates and, for bonds, additional issuance fees usually apply.

The sale of the customer loan to an external investor, known as receivables sale, is also rarely used. This typically also incurs high costs for the institutions. In addition, the borrower must always be informed in advance.

Expensive Refinancing Affects Customers

The question of where the money for a loan comes from also has consequences for the borrower, as a bank attempts to pass on the resulting additional costs to its customers.

Interest costs are not only influenced by the source of refinancing; the financial situation of the bank also plays a role: the better its equity position and creditworthiness, the better the terms at which it can itself take out loans.

Conversely, this means: if the financier does not currently have optimal creditworthiness, it represents a higher risk for lenders and must refinance its loans at higher interest rates. This typically also affects the loans of borrowing companies — their interest rates are higher too.