Interest Rate Concepts

In market economy, there are many economic-financial categories, including credit and credit interest rate which are two of the most important ones.

Credit activities are borrowing and lending activities. The capital-using relationship between borrowers and lenders bases on the principles of reimbursement. Lenders who are in excess of capital have opportunities not only to preserve but also capital get profit. Borrowers who are short of capital have chances to get additional capital to meet production, business or living needs. Therefore, owing to the credit activities that a large proportion of capital in the economy are mobilized, concentrated and distributed from temporary capital surplus sections to shortage ones to meet different needs of all entities in the economy.

Indispensable leverage and tool in credit activities is interest rate. Interest rate of bank credit is the ratio in percentage between income and amount of loan for a certain period. Thus, interest rate is the price of using capital which is associated with banking, credit, and all economic activities related to deposits and loans.

On the other hand, the interest rate is a sensitive and effective tool of national monetary policy for controlling the economy. Through changes in the level and structure of interest rates in each period of time, Government may affect the size and density of investment’s types, so that affect the structural adjustment process, the growth, production, unemployment and domestic inflation. Moreover, in certain conditions of an open economy, interest rate policy is also used as a tool for controlling capital flows for a country, affecting and regulating stability of exchange rates. This does not only impact directly on investment and development but also the balance of payments and international trade relations of a country.

Therefore, in the developed countries which are following the financial liberalization policy, interest rate is formed based on the market. It means that the relationship between demand and supply will determine the interest rate.

Some criteria for classification of bank credit interest rate:

There are many criteria for classification of bank credit interest rates.

  • Based on credit terms, interest rates of bank credits were divided to three types. Short-term interest rate is applicable to short-term credits, medium-term interest rate is applied to medium-term credits and long-term interest rate is applied to long-term credits.
  • Based on the stability of interest rates, they are divided to a floating rate and fixed rate. Floating rate can change up and down, but fixed rate is the interest rate applied during the credit period.
  • Based on the type of credit interest rates, interest rates are divided to different categories. Deposit interest rate is paid on deposits, which has different levels depending on the time-limit and scale of deposits. Loan interest rate is the amount of money that borrowers pay to banks by using bank loans. It is applied to calculate the loan interest that customers must pay to the banks. Discount rate applied to bank loans in the form of commercial bill discounting or other customers’ undue valuable papers. It is calculated by the ratio in percentage of the papers’ par value and deducted as soon as banks make loan to customers.
  • Rediscount interest rate was applied in the process of capital refinancing, in form of re-discounting commercial bill or other undue short-term valuable papers of the banks. It is calculated by the ratio in percentage of the papers’ par value and also be deducted as soon as the State bank makes loans to commercial banks.
  • Interbank interest rate is the interest rate that banks apply for others’ loans on the interbank market. It is formed by money supply-demand relationship of credit organizations and under the control of State Bank’s capital refinancing interest rate. Base rate is the interest rate banks use as the basis to determine the rate of their business.

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