World’s economy can’t be imagined without banks, which plays a crucial role in the growth of any nation. Progress of a nation is often scaled in terms of the degree of development of its banking system. Banks render a plethora of functions, in which the most important is lending/advancing loans.
Be it an investment for a company, requirements to purchase a house/car/etc or for any personal use, loans quench the need in every case. A loan, alongside its benefits, also comes with an obligation to repay the same along with a certain amount of interest. The interest rate, in turn, depends on a number of functions.
As per the Reserve Bank of India, the banks need to choose an external factor in order to decide the interest rate. In this, the repo rate (the rate at which the RBI advances loan to the commercial banks) is one of the popular and key indicators. Apart from the quantitative variants, interest rates also vary in quality. The major differentiations are as follow:
- Fixed Interest Rate: Loans availed on the basis of fixed interest rate have a fixed EMI amount for amortization. As the name suggests, the fixed interest rate is not influenced by any factors and remains constant as per a pre-decided figure. This type of loan is best for people who have a strict budgetary constraint.
- Floating Interest Rate: Unlike the fixed interest rate, the floating interest rate is subjected to change under the influence of external factors. This, in turn, changes the EMI amount and subsequently the entire reimbursement. However, they are generally less than the ‘fixed’ sibling.
- Hybrid Interest Rate: This is composed of both the fixed and floating interest type. A loan advanced using hybrid interest rate has the first part of the repayment tenure based on the fixed interest rate, while the other part includes the floating interest rate.
Frequently Asked Questions (FAQ)
1) What do interest rates signify?
Interest rates are the price which is paid back to the lender by the borrower for using their money. Banks let you use their money at a specific rate of interest. There are various types of interest rates for different types of lending like mortgages, business loans, credit cards and many others.
2) Who has the power to manage the interest rates?
The RBI mostly fixes the interest rates. It is mainly concerned with bankers. When there is any change in the interest rates, there are broad economic effects. Money is one of the essential fuels for economic activity to take place. The economy of a nation increases when its citizens spend more. So the interest rates are managed to suit all sections of the society.
3) Why doesn’t interest stay low forever?
It is a matter of fact that keeping lower interest rates will allow people to spend more, and the economic activity will increase. It holds good for a certain amount of time. This, however, gives rise to newer problems like inflation.
4) What is the current interest rate?
The interest rates differ from one bank to another. However, all the banks have kept their rates more or less close to each other. In India, DBS bank now offers the highest interest of 7%.
5) What happens when banks increase the rate of interest?
The interest rates of banks are generally increased in the scenario of inflation. The money supply in the economy will, and the money becomes costlier. In the situation of inflation, the banks are forced to pay a higher percentage of interest to RBI.
6) What is the effect of an increased REPO rate?
REPO rate forms one of the essential parts of the Indian economy. The rate regulates all the countries money supply, liquidity and level of inflation. They have a direct relationship with the cost of borrowing loans from banks. So higher the REPO rate, higher will be rates of interest for loans borrowed from banks.
7) Why is the rate of interest of banks higher than the REPO rate?
REPO rate refers to the rate of interest in which RBI provides loans to the commercial banks. Taking a loan from the central bank, all the commercial banks offer loans to the public. The bank rate of interest is higher than the REPO rate because it is used for a more extended period.
8) What is meant by reverse REPO rate?
Reverse REPO rate is the rate of interest that RBI pays to the banks when they deposit their surplus cash with RBI. It is, in general, the rate of interest in which RBI borrows money from banks. It is only possible when the banks have got enough surplus cash. It is one of the ways banks can raise additional interest from their funds.
9) What are the current REPO and reverse REPO rates?
RBI has all the power to keep on regulating the REPO rates as per the changing economic factors in the country. The changes can’t be very often as it directly affects every part of society when the rates are changed, a particular segment of the society gains while some lose. The prevailing REPO rate is 6.5%, and the reverse REPO rate is 6.25%.
10) How can inflation be controlled?
Inflation in the economy can be controlled by increasing the REPO rates. When the rates are increased, the affair of borrowing from banks gets difficult. It slows down the running economy, and it has its negative impacts on the growth. This, in terms, brings down the inflation.