What is an interest rate

What is an interest rate

An interest rate is the percentage that the lender receives for the use of funds. The billing period during which it is accrued varies. It can be a month, a quarter, or a year (details are specified in the agreement).

What affects the interest rate

When calculating the interest rate, the Central Bank's key rate, at which commercial banks borrow money, is taken into account. Based on this, it is clear that the loan interest cannot be lower than the Central Bank rate. An exception is government-supported lending programs, for which the overpayment will be lower. 

Each organization determines the interest rate on loans and deposits independently. When calculating the terms, specialists take into account the Central Bank rate and add their own margin to it. 

The loan rate will always be higher than the deposit rate. This is because the difference between these interest rates represents the bank's profit. Let's clarify the situation with a simple example. 

A client deposited 400,000 RUB in the bank at 6% per annum. Following them, a borrower applied to the credit institution needing 400,000 RUB on loan. The bank will provide this amount for use at 15% per annum. In this case, the financial institution simply acts as an intermediary, transferring funds from one person to another and receiving remuneration for this. 

Upon completion of the one-year loan term, the lender will receive 460,000 RUB from the borrower. The bank will give the depositor 24,000 RUB along with the deposit as remuneration, and the 36,000 RUB difference will become the credit organization's margin. 

The borrower's solvency is extremely important for the bank. They must timely pay interest for using the funds and repay the debt. It is equally important that deposits remain in the bank for the entire duration of the agreement, which is ensured very simply: if the agreement is terminated, the client can get their money back but will lose the interest. 

Main factors affecting interest rates on deposits and loans

Loan and deposit rates are influenced by the following factors:

1. Term. In lending, the overpayment depends on the term of the agreement: the longer it is, the more the client will pay the bank. In the case of a deposit, the situation is the opposite: the longer the money remains at the disposal of the credit institution, the greater the profit the depositor will receive. 
2. Amount. The larger the deposit, the higher the profit, and the larger the loan amount, the higher the loan interest. 
3. Key rate and inflation. Interest rates on both loans and deposits increase. 
4. Provision of collateral (in lending). Collateral increases client reliability and helps slightly reduce the interest rate. 
5. Client's financial standing. It allows reducing the loan interest rate, but does not affect the profit from the deposit. 

Early withdrawal of a deposit may result in recalculated or forfeited interest. Terminating the agreement will cause financial losses for the client. Early loan repayment will reduce the overpayment. 

What types of interest rates exist

Interest rates may have specific features depending on the agreement terms:

• by the possibility of changes, they are divided into fixed and floating; 
• by inflation adjustment, into real and nominal; 
• by the method of interest payment, into anticipative and decursive. 

A fixed loan rate remains stable throughout the entire term of the agreement. If a client opens a deposit at 7.5% per annum, these terms will be maintained throughout the entire validity period, despite fluctuations in the Central Bank of the Russian Federation rate and the country's economic situation. 

A floating rate changes according to specific formulas. As a rule, it depends on the key rate of the Central Bank of Russia. When issuing a loan in foreign currency, the current exchange rate may also be taken into account. 

The real interest rate is calculated taking inflation into account, while the nominal rate is calculated without it.

 The decursive rate is applicable to deposits. In this case, interest is paid after the expiration of the agreement term along with the principal amount. The anticipative interest rate is a percentage of the loan agreement amount. It is calculated based on the final amount. The lender's remuneration can be paid at the time the funds are provided, as well as during their use, for example, monthly or once a quarter.

What a zero interest rate means

Banks in Russia do not issue 0% loans to the public. Such terms are not found in consumer lending; they are used exclusively at the interstate level, when one country issues a loan to another state. 

Consumers can take advantage of a zero interest rate only at MFIs, but under certain conditions. Major microfinance organizations offer their clients promotional terms to get a loan without overpayments. Why do MFIs do this? Competition in this sector is extremely high, and this is how lenders attract the attention of potential borrowers and try to increase the level of trust. After receiving an interest-free loan, the client will likely turn to a trusted MFI when they need money again. 

The impact of the interest rate on the economy

The interest rate determined by the Central Bank of the Russian Federation is an important indicator reflecting the economic situation in the country. It is also a monetary policy tool. 

The interest of foreign investors and the volume of their investments in the state economy depend on the country's interest rate level. For the domestic economy, a high interest rate can be a negative factor, as it reduces the demand for loans among the population. Because of this, its increase is used only in exceptional cases, for example, to control inflation at the required level.

Simply put, an interest rate is the amount of remuneration for using borrowed funds. Deposit yield or loan overpayment depends on it. 

Frequently Asked Questions

To conclude the article, we will answer the most frequently asked questions on the topic.

Can a bank unilaterally change a fixed interest rate? 

Banks do not have the right to change terms in fixed interest rate agreements without obtaining the client's consent. This norm is enshrined in the Civil Code of the Russian Federation. If a bank changes the agreement terms, it violates current law.  

Can banks issue interest-free loans? 

Credit institutions cannot provide funds to their clients for use without interest. In this case, they would lose their profit, and their operations would be unprofitable. The same applies to deposits. If a credit institution does not pay interest to its clients, they will not bring their money to the bank and will keep it at home. 

What benefit does a banking organization receive by issuing cards with a grace period? 

The optimal lending option for the public is using a credit card with a grace period, but even in this case, the bank does not forget about its profit. The credit institution will receive its remuneration for the client making purchases via cashless payment. Also, not all credit card users pay attention to the terms of the grace period, and may accidentally withdraw cash or make transfers to acquaintances—in this case, the bank's income will increase.