Rate of Interest

By: EconomyWatch Content   Date: 3 November 2009

About The Author

EconomyWatch Content

Follow The Money

EconomyWatch, Content Team

 

  • Dot Div
  •      

The rate of interest is the price that a borrower pays for using the money loaned by a lender. Fluctuations in the rate of interest have a strong impact on a nation’s economy. Interest rates play a key role in the effective functioning of businesses or in making them bankrupt. In the absence of rate of interest, the economy of a country can suffer huge losses.

Rate of Interest: Lenders and Borrowers

The borrower has to pay the price, i.e. interest, for getting access to the money which does not belong to him. The lender runs the risk of not being paid back the lent money. Inflation also plays spoilsport by decreasing the purchasing power of the money that the lender gets repaid in the future. Thus, the rate of interest compensates for the risks borne by the lender. In this sense, interest is income for one party and cost for another.

Factors Determining Rate of Interest

The rate of interest is influenced by the following factors:

Supply and Demand: The levels of interest rate affect the demand and supply of credit. Interest rate rises with an increase in demand of credit and vice versa. On the contrary, interest rate falls with an increase in supply of credit and vice versa.

Financial institutions increase the supply of credit by increasing the availability of money for loan seekers. For instance, when the income of banks increases through new customers buying various products and services, the former puts that money in lending. An increase in lending leads to a decrease in the interest rate.

The supply of credit shrinks when borrowers defer loan repayment. For instance, if a credit card holder does not make timely payments, s/he decreases the availability of money in the market. This leads to increase in the rate of interest.

Inflation: Mounting inflation leads to rise in interest rates. This is because the purchasing power of money falls during inflation. Hence, lenders try to compensate for this by charging higher interest rates.

Government: The government of a nation may also step in to regulate interest rates and to stabilize the economy.

 


  • Dot Div
  •      

Most Popular in Interest Rates

Related Links
blog comments powered by Disqus