What is meant by Interest?

When we borrow money, we are expected to pay for using it - this is known as Interest.

Interest is an amount charged to the borrower for the privilege of using the lender's money. Interest is usually calculated as a percentage of the principal balance (the amount of money borrowed).

The percentage rate may be fixed for the life of the loan, or it may be variable, depending on the terms of the loan.

What factors determine interest rates?

When we talk of interest rates, there are different types of interest rates :

i) Rates that banks offer to their depositors.

ii) Rates that they lend to their borrowers

iii) Rate at which the Government borrows in the Bond / Government Securities market,

iv) Rates offered to investors in small savings schemes like PPF

v) Rates at which companies issue fixed deposits.

The factors which govern these interest rates are mostly economy-related and are commonly referred to as macroeconomic factors.

Some of these factors are :

1. Demand for money

2. Level of Government borrowings

3. Supply of money

4. Inflation rate

The Reserve Bank of India and the Government policies which determine some of the variables mentioned above.