Why Is There An Interest Rate?

Why is there an interest rate?

An interest rate is the cost of money. Therefore it’s the rate a bank or other lender charges to borrow its money, or the rate a bank pays its savers for keeping money in an account.

Interest rate levels are a factor of the supply and demand of credit: an increase in the demand for money or credit will raise interest rates, while a decrease in the demand for credit will decrease them. Conversely, an increase in the supply of credit will reduce interest rates while a decrease in the supply of credit will increase them.

The supply of credit is increased by an increase in the amount of money made available to borrowers. For example, when you open a bank account, you’re actually lending money to the bank.

Depending on the kind of account you open. A certificate of deposit will render a higher interest rate than a chequing account, with which you have the ability to access the funds at any time. The bank can use that money for its business and investment activities.

In other words, the bank can lend out that money to other customers. The more banks can lend, the more credit is available to the economy. And as the supply of credit increases, the price of borrowing interest decreases.

Credit available to the economy is decreased as lenders decide to defer the repayment of their loans. For instance, when you decide to postpone paying this month’s credit card bill until next month or even later, you’re not only increasing the amount of interest you’ll have to pay but also decreasing the amount of credit available in the market. This, in turn, will increase the interest rates in the economy.