What is Interest Rate? I Term of the Week I

Interest Rate: The interest rate is the amount a lender charges for the use of funds expressed as a percentage of the principal.

Types of Interest Rates:
🔘 Policy Rate: Most essential rate through which SBP conducts monetary policy
🔘 Overnight Repo Rate: Rate at which banks borrow funds from each other
🔘 Savings Rate: Rate that commercial banks offer when you deposit funds with them

00:08 - 01:06 Introduction
The interest rate is the amount a lender charges for the use of funds expressed as a percentage of the principal. This can also be thought of as the cost of borrowing funds.

01:09 - 02:13 Types of Interest Rates:
There are various types of interest rates in Pakistan's banking and financial sector. The policy rate is the interest rate that is used to conduct monetary policy and is controlled by the State Bank of Pakistan. Examples of other interest rates are the overnight repo rate that is charged by banks for lending funds to other banks, and the savings rate that is offered by commercial banks to savings account customers. The policy rate is the most consequential interest rate because all other interest rates in the economy are correlated with it.

02:15 - 03:21 Relation b/w Inflation and Interest Rates:
There is a general tendency for interest rates and the rate of inflation to have an inverse relationship. In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend. This causes the economy to grow and inflation to increase. The opposite holds true for rising interest rates. As interest rates increase, consumers tend to borrow less which results in lower spending. As a result, inflation decreases.

03:22 - 04:18 State Bank's use of Interest Rates:
The State Bank of Pakistan manipulates the policy rate to affect the inflation rate. For example, the policy rate in Jan 2018 was 5.75%. Over the course of the next two years, the policy rate increased to 13% by March 2020. This persistent rate hike was done to counter increasing inflation which was moving into double digits (greater than 10%).

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