What Are Match-Rate Funds?
Match rate funds are loan funds which have their interest rates matched (or extremely close) to the interest rate on the source of the funds loaned out. This term is especially used in the European banking system to describe the relationship between the deposits a bank is currently holding and its outstanding loans.
Understanding Match-Rate Funds
Match rate funds are better understood with the lending process carried out by banks. When account holders make cash deposits in their accounts, the bank converts this cash into loans that are made out to borrowers. To compensate account holders for the deposit, the bank pays an interest rate on the funds in the account. The funds are loaned to corporate or individual borrowers who pay interest to the bank until the entire loan amount is repaid. The difference between the interest rate paid to depositors and the rate paid to borrowers is the spread that represents the bank’s profit. When the interest rates on the money received and loaned out are closely matched, the money is referred to as a match rate fund.
Example of a Match-Rate Fund
Let's assume that a bank accepted a $100,000 deposit and agreed to pay 2% interest on it for five years. Then the bank loaned that $100,000 out at a rate of 2.05%. Because the spread between the two rates is nearly zero, it's called a match-rate fund.
A securitization lender would be a typical user of match-rate funds. The lender may buy loans from the secondary mortgage market. The interest rate on these loans will be paid to the lender/buyer who will proceed to package the loans to sell as securities to other investors. These loans would likely be match-rate funds as the rate the lender receives from the seller and the rate it gives to its buyer will be closely matched.
Match-rate funds typically come with very high penalty fees for early prepayment because the intermediary has agreed to pay a specific interest rate to the depositor. If prepayment was not discouraged, the intermediary could end up paying interest after it had stopped receiving interest payments.