Importance of Interest rate in Banking

Interest rate is the cost incurred on borrowing money. Interest rates are very important for Banks when they act as lenders, as when they give out loan they also have to bear some kind of risk, especially if the loan is against some kind of asset. Monetary value and assets always have a variable rate and through the passage of time its value increases and by the time borrowers pay back the money to the lender the purchasing power of that asset may have decreased. To avoid such situations, lenders charge an amount of fee, which we know as the interest rate. When it comes to borrowers taking a loan, for them too it is a high risk factor. Usually money is borrowed to be spent on something urgent that could prove to be beneficial to the borrower.And for that benefit which could amount much higher than the original loan money borrowed has to be paid for in the face of interest rate. In terms of business, interest rate is the cost for money borrowed, the rate of which changes from time to time and it is the income of lending money. When there is an increase in demand for credit(to buy more luxury items) and mortgages (to buy more homes) then the interest rate will increase, and when there is a decrease in demand so is there a decrease in the rates. But when there is an increase supply of credit, then the interest rates drop, since banks can give more money to debtors, they reduce the interest rates. Not only supply and demand affect interest rates, even inflation does so too. When a nation is experiencing inflation, people tend to need more money and since banks are short on investors (who are themselves short of cash) they raise the amount of interest rates.