How are bank interest rates governed?


This might be a tough question to address since policies surrounding the governing of bank interest rates are usually controlled by the Central Bank in each country. They usually have regulations based on the country’s economic strength.  In the United States, the interest rates have both federal and state regulations, making it pretty fragmented, as compared to most countries which are pretty centralized.

The central bank of a country has many ways of controlling interest rates.  The initial step in doing so is by creating policies that ensure liquidity for the country through stable prices.  The central bank then will manipulate the money supply through retail banks.  It adjusts the interest rates depending on the bank’s need to keep money flowing.

If the central bank’s monetary policy makers want to increase money supply, they will decrease the interest rate, therefore, making it more attractive for financial institutions to lend and borrow money. On the other hand, if the money supply needs to be reduced, then interests are raised in such a way that more funds are deposited and fewer loans are requested of the central bank.

Some economists argue that the governing of interest rates is not about the rates themselves but it is about the money. 

Other factors that determine interest rates or that compel central banks to make adjustments include:

  • Inflation - Lenders will usually require higher interest rates to compensate for potential losses in the future when money has decreased in power.
  • Supply and demand - The concept here is rather easy. When you open a bank account, for instance, you are actually lending your money to the bank.  They will pay you an interest for this.  With this, they keep the rights to use your money for investment and banking activities, meaning that the bank is lending your money to other customers.  The available credit then depends on the amount of money banks can lend. On the other hand, if you decide to pay your credit card for this month until next, the amount of market money available decreases, plus your interests increase.

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