Loan interest is a cash consideration received by lenders for providing them with funds. In essence, this economic category represents the price of the loan that the borrower pays for using the funds to the lender.
Loan capital and loan interest
Free cash assets that appear at enterprises, companies and other economic entities, and then transferred for temporary use to other firms, are loan capital. They make their movement in the market and have a price in the form of loan interest.
The existence of this indicator is due to the presence of commodity and monetary relations. Since ancient times, people began to provide various types of loans in kind with interest payments in the form of grain, livestock, etc. In the conditions of issuing money in the form of a loan, interest is paid accordingly in cash.
Today, the loan interest appears when the owner transfers a certain value to another for temporary use. This is usually done for productive consumption. The lender, refusing the current use of material resources, sets the goal of generating income on the loaned value. The entrepreneur who attracts borrowed funds does this to rationalize production, as well as increase profits, from which he will be obliged to pay interest.
Loan interest: formation mechanism
Under market conditions in the field of credit relations, the indicator of loan interest is approaching the average profit level. In the conditions of free movement of capital, credit funds rush into the sphere that allows you to get the most profit. At an income level in the manufacturing sector above the percentage of the loan, funds are transferred to this sector and vice versa. If the rate of return and profitability in a certain sector of the economy is higher than the rate of loan interest, then cash flows into such investments.
Market interest rates for various assets vary. Their level can both increase and decrease. The formation of the level of interest is influenced by macroeconomic and private factors that underlie the interest rate policy of lenders.
One of the macroeconomic determining factors is the ratio of supply and demand of borrowed funds. With a decrease in demand for borrowed credit assets, which is observed during periods of economic downturn, the interest rate decreases. The opposite effect occurs when the Central Bank reduces the volume of lending to the economy, as a result of the loan interest increases.
The interest rate is influenced by the level of development of the securities market and monetary assets, which directly depend on each other. So, with an increase in the yield of securities financial institutions make rate adjustments. This dependence is more pronounced with a more developed securities market.
The loan interest depends on the deficit of the state budget and the need to cover the lack of money with borrowed funds. In this case, the interest rate increases on the loan capital market, which ultimately leads to a decrease in private investment, as many of them lose their profitability.
Factors affecting the interest rate include the following: the state of the balance of payments, national currencies, international capital migration, inflation expectations and processes, the amount of cash accumulation in the population, the tax system, and the risk factor for credit transactions.
Particular factors arise based on the specific conditions of the lender, on his position in the market for borrowed resources, on the nature of operations and the degree of risk.