Loan interest: the formation mechanism and determining factors

Loan interest is the monetary reward received by creditors for providing them with funds. In fact, this economic category represents the price of a loan that a borrower pays for the use of funds to a lender.

Loan capital and loan interest

Free monetary assets that appear in enterprises, companies and other economic entities, and then transferred to other firms for temporary use, are loan capital. They produce their movement in the market and have a price in the form of a loan interest.

The existence of this indicator is due to the availability of commodity and money relations. Since ancient times, people began to provide various types of loans in kind, paying interest in the form of grain, livestock, etc. In conditions of issuing money in the form of a loan, interest is paid accordingly in cash.

Today, the loan interest appears in the case 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, aims to obtain income for the loaned value. Attracting the same borrowed funds, an entrepreneur does this to rationalize production, as well as increase profits, from which he will have to pay interest.

Loan interest: the mechanism of formation

In the conditions of the market in the field of credit relations, the loan interest rate is approaching the average level of profit. In conditions of free movement of capital, credit funds are directed to the sphere that allows them to obtain the greatest profit. When the level of income in the manufacturing sector is higher than the percentage of the loan, the funds are moved to this sphere and vice versa. If the rate of profit and profitability in a certain sphere of the economy is higher than the rate of loan interest, then the money flows into such investments.

Market interest rates for various assets are changing. Their level can either increase or decrease. The level of interest is influenced by macroeconomic and private factors that underlie the interest rate policy of creditors.

One of the macroeconomic determinants is the supply-demand ratio of borrowed funds. With a decrease in demand for borrowed credit assets, which is observed during periods of economic decline, there is a reduction in the interest rate. The reverse effect arises when the Central Bank reduces the volume of lending to the economy, as a result, 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. Thus, with an increase in the yield of securities, financial institutions make rate adjustments. This dependence is more pronounced with a more developed securities market.

Loan interest depends on the deficit of the state budget and the need to cover the lack of money with borrowed funds. In such a case, the interest rate on the loan market increases, which ultimately leads to a reduction in private investment, as many of them lose profitability.

Factors influencing the interest rate include: the state of the balance of payments, national currencies, international migration of capital, inflation expectations and processes, the amount of cash accumulation in the population, the taxation system, the risk factor in conducting credit transactions.

Particular factors arise based on the specific conditions of the creditor's activity, on its position in the borrowed resources market, on the nature of operations and the degree of risk.