Interest Rates
Interest rate is the rate at which interest is paid by the borrower to the lender, for the use of money that they borrow. For example, a man takes a loan from a bank to buy a new car. In return, the bank receives interest at a pre-specified interest rate for deferring the use of these funds and instead lending it to the customer. Interest rates are usually expressed as a percentage rate charged over the period of one year.
Why Interest rates change
- Political Short Term Gain: Lowering the interest rates may give the economy a boost. However, it is for short term only because this will soon be offset by the inflation.
- Inflation: Due to inflation, the money looses its purchasing power. Hence a given amount of money buys fewer goods in the future than it will buy now. The borrower has to compensate for this, hence interest is charged.
- Deferred Consumption of Money: By lending the money the lender delays spending it on consumption of goods. Since goods now are preferred over goods later, the interest rates will be positive in the economy.
- Taxes: Since some of the gains from interest may be subject to tax, the lender may charge a higher Interest rate to make up for this loss due to tax.
- Risks of investment: There is a risk that the borrower may go bankrupt or may default.Thus the lender usually charges a risk premium.
Interest rates target is also an important tool of the monetary policy of the economy and its usually taken into account when dealing with variables like inflation, investment and unemployment.
Factors Affecting Interest Rates
Interest rates depend on various factors. Fluctuations in money market, demand & supply of money in the economy affect the interest rates. Three Major factors that determine the Interest Rates are:
- Policies of the central bank
- State of Economy
- Inflation
Term Deposit Interest Rates in India
Follow the link to check out Bank fixed deposit interest rates in India