Of course, by now many of us are frantic because of the ECCB’s decision to lower the interest rates on savings accounts at commercial banks. You may be wondering, how will I benefit from this or what does this mean? No need to worry! This article will shed some light on the basics of interest rates as well as what you can and cannot expect in the near future.
Interest rates can simply be defined as the amount charged by a lender to a borrower for use of their assets. When one deposits money at a bank, the institution will pay you a rate of interest for the use of your funds for investing and for lending to other people who do not have access to those funds. The bank will in turn charge people who require loans a specific rate of interest.
The profit that a bank or anyone can make from borrowing and lending money is the difference between the interest on lending minus interest on savings, hence the reason why the rate on lending is higher than the rate a bank will pay you for your savings. Imagine if a bank were to offer you a 3% interest rate on your savings and then lend those funds at a rate of 3%. This means that the bank would make no profit and would therefore not be able to meet expenses such as paying its employees.
Banks and other financial institutions are limited as to their freedom to set interest rates. They are regulated by an overseeing body who sets floors for interest rates (prime rates). The interest rates on savings are standardised across the board. Some banks may choose to offer a slightly higher interest rate than the primary rate. These products come with special terms and conditions and in most cases require you to deposit and maintain a minimum account balance.
Interest rates are, in most cases, applied as a percentage of an amount for the period of one year, which can sometimes be broken down in different periods such as daily, monthly, semi-annually, quarterly and yearly. Most interest rates on savings are applied quarterly. However, regarding loans, they are applied yearly and compounded monthly. The interest rate may be higher, taking into consideration the likelihood that the loan applicant may not be able to repay the loan, which poses a risk to the bank. The higher the risk, the higher the interest rate.
Central Banks reduce interest rates whenever they wish to stimulate investments and increase lending and consumption in an economy. Over the past few years, there has been a lot of money circulating in the Eastern Caribbean Currency Union and, as a result, the ECCB decided to lower interest rates on savings from 3% to 2% with the hope that banks would lend more.
Excess supply is supposed to reduce interest rates and, in turn, increase demand for loans. By now, I’m sure you’re wondering whether or not your bank will offer you lower interest rates for loans. That is possible. However, it is entirely up to the bank and their credit risk policy. A low interest rate, especially on loans, can be risky and lead to excessive growth, which can then lead to inflation. Inflation erodes purchasing power and can thereby lead to unsustainable economic expansion.
Low interest rates on savings can discourage people from saving and force them to find an alternate means of investing. After all, saving your money at a bank is indeed an investment since you earn a rate of return.
Don’t be anxious. There is no need to worry because the ECCB has lowered the interest rate on savings. Has your bank been giving you problems lately when you tried to obtain a loan? Let’s hope they begin to engage in aggressive loan campaigns with attractive rates that will allow you to achieve that dream home or car that you’ve been wishing for.
