| Cross a street, or just sit in a coffee shop close to a | | | | The more risk a bank has to bear, the higher the rate |
| busy street and you will see them - flapping from | | | | of interest it will charge. |
| lampposts, splattered on walls or passing in front of | | | | Another factor that will affect interest rate at this |
| you on the side of large vehicles. "Buy your first | | | | stage is the expected inflation rate. If lenders expect |
| HOME! Lowest Interest Rate Ever", "Get a personal | | | | inflation to go up by 2% the following year, then they |
| loan. 0.01% above BLR", or even "Zero rate interest. | | | | will add the 2% to their original 4%. Hence the final loan |
| Get your loan now." | | | | may carry an interest rate of 6% for the borrower. |
| The word interest rate seems to be everywhere we | | | | This is because money institutions do not attach value |
| look. Most of us sort of have an idea of what they are | | | | to the numbers, but instead place value on what the |
| and that is why whenever we start talking about rates | | | | amount can buy or its purchasing power. For example, |
| of any kind, we tend to use the word "you know..." to | | | | barrel of fried chicken costs $10.00 now but it is |
| close to our opinions. A few even make do by | | | | expected to increase to $10.20 because of a |
| comparing the rates of different banks or loan types. | | | | projected inflation of 2%. Current value x (Base year + |
| This one is better than that, or that is the best of all. | | | | Inflation rate) = $10.00 x (1 + 0.02) = $10.00 x 1.02 = |
| But how are these rates defined? Will the definition | | | | $10.20 |
| affect how high or low the rates are? Some loans | | | | Hence if the chicken shop continues to sell the barrel |
| may even appear to have the same interest rate but | | | | at $10.00 the following year, after a 2% inflation, then |
| if you read the contract clause carefully, you may find | | | | the real value of the barrel has gone down to $9.80 |
| different conditions attached to either one of them. | | | | Fixed price x (Base year / new rate) = $10.00 x (1/ |
| Usually what we see appearing on the news are | | | | 1.02) = $ 9.80 |
| announcements from the Central Bank about whether | | | | For that reason banks or lending institutions will try to |
| or not it will be raising rates. This is a big deal to | | | | project the expected inflation into the loan; else the |
| investors and business owners because it will affect | | | | value of its purchasing power will decrease over time. |
| their demand for money. Banks usually add a small | | | | Demand |
| amount onto the Base Lending Rate, so that they can | | | | The next factor that influences interest rate is market |
| earn a little for their institution. So when the total rate is | | | | demand. The more people demand money, the higher |
| 4%, a business have to pay 4 cents for every dollar it | | | | the interest rate becomes. Applying the logic of the |
| borrows for a year, and when the rate is 5%, it means | | | | demand-supply curve, when the interest rates for |
| the same business have to pay 5 cents for every | | | | lending go up, more people will be willing to invest or |
| dollar. Consequently, a 4% rate is considered cheaper | | | | lend their money. This situation usually happens in times |
| than a 5% rate. | | | | of economic growth, so it is actually a fuel that feeds |
| So let us look at a few things that will affect interest | | | | on itself because during times like these, there are |
| rate. | | | | more jobs, and people who work get better pay so |
| Central Bank | | | | they have more money to invest. And since |
| Money, like goods and services, is a form of product | | | | corporations are willing to pay big dividends or interest |
| supplied by banks and finance institutions to the public. | | | | for these kinds of loans, people will put in more money |
| If, for example, the Central Bank increases interest | | | | into their portfolio. |
| rate then the demand for loans will fall because it has | | | | Hence one of the most crucial role of the Central Bank |
| become more expensive to borrow money. This is | | | | is to control the market movement, so that this fragile |
| usually done to slow down problems like inflation, when | | | | balance is not disrupted, and the Securities Commission |
| prices rises too quickly thus distressing the lifestyles of | | | | is there to make sure that everyone plays fair |
| the lower income group. However, the bank must also | | | | because business is built on trust and contract, and if |
| keep an eye on the job market while doing this, | | | | that structure is perceived to be not in place, the |
| because if entrepreneurs and businesses stop | | | | market will suffer, a situation that brings us to the next |
| expanding or cut down because loans have become | | | | item that affects interest rates. |
| expensive then the job market will be affected. | | | | Confidence |
| On the other hand, the Central Bank can also | | | | The fourth factor is how willing people are to 'save' |
| decrease interest rate, which has the effect of | | | | their money in the banks, investment or financial |
| reducing the price of a loan. This is usually done when | | | | institutions. All monies saved become part of the |
| the economy is slow and it needs people to start | | | | supply group. Hence during a recession, interest rates |
| spending to stimulate it. The reasoning goes that if | | | | may actually rise when people rush to take out their |
| rates are lowered then consumers will take out loans | | | | money from the banks, which has the effect of |
| to buy items like a house, which will become a catalyst | | | | reducing the supply of monies in the market. However, |
| to the construction and real estate industry. These | | | | this only happens if the supply drops faster than the |
| firms in turn will also find it cheap to borrow money to | | | | demand for monies. In other words, when people stop |
| employ more people, thus putting in more spending | | | | entrusting their money to financial institutions, bad things |
| money in the market. | | | | begin to happen. |
| Risk | | | | In summary, |
| That is how interest rate manipulation is supposed to | | | | - The Central Bank rate is based on economic |
| work in theory. However, individual rates - home loans, | | | | indicators and government policy |
| car loans, education loans - are dependent on | | | | - Risk is based on the financial institutions' product type, |
| consumer demand as well as their eligibility for the | | | | market trend, client criteria and policy and strategy, as |
| product. For example similar home loans may have | | | | well as outside influences like inflation |
| different interest rates because one may require that | | | | - Demand is based on consumer assimilation and |
| the lender buys an insurance to cover default on the | | | | product promotion |
| loan, while another demands the home as collateral. | | | | - Confidence is based on market conditions, political |
| The risk of a loan, in terms of the age of lender, | | | | situation and rumours which are at times related to |
| collateral, job prospect of lender and number of years | | | | fraud. |
| on the loan will affect the interest rate attached to it. | | | | |