The wealth of a nation is directly proportional to low interest rates and low inflation. Looks like 2.5 years of low rates are hurting the middleclass
Times of India
A climb in inflation rates has always seen a frown on the foreheads of countless borrowers. Hike in inflation rate has often been succeeded by lenders hiking the interest rates on home loans. Banks have inserted clauses in their loan agreements that empower them to increase interest rates under special circumstances. And it is not only the floating but also fixed rate borrowers who have borne the brunt of increased rates.
So how does inflation impact home loans?
Inflation is the rise in general level of prices as against the purchasing power of the common man. Inflation in small doses is always considered healthy for an economy. Increasing prices and wages eliminates the need for negotiating and making downward price and wage adjustments that is usually associated with deflation. Inflation is a driving factor that motivates people to invest rather than save money over the longer run.
An out-of-control northward-bound inflation is detrimental to the economic fabric of a nation. When there is increase in money in circulation (government printing money in excess) when compared to the ability of the economy to supply, we see a demand-pull inflation. Then there is the cost-push inflation which can occur from certain events like scarcity of crude oil supply. Whatever be the cause, inflation hurts people, particularly those who have locked themselves in fixed instruments like the pensioners. Inflation can lead to a wage spiral where trade unions may demand more wages, and consequently industrial productivity will suffer.
Inflation can be reined by increasing interest rates. When the central bank hikes interest rates, it reduces money supply. This is the oldest method of controlling inflation. Increase in rates is associated with unemployment and fall in production that is immediately followed by a curb on unhindered price increase.
The Reserve Bank of India (RBI) is justified in increasing the repo and reverse repo rates to bring inflation under check. Repo rate is the benchmark rate at which the RBI lends to banks for a short term. All the banks that borrow money from the RBI have to bear this cost. Often used in conjunction with the repo rate is the reverse repo rate. When the RBI borrows money from banks against its securities, the interest rate at which it does so is known as reverse repo.
The reverse repo rate can also be defined as the return banks earn on excess funds parked with the central bank against Government securities.
When the RBI increases the repo rate, a natural fallout is an impending increase of the bank rate. This will soon snowball into hardening in interest rates - both lending and deposit rates. The lending rates or prime lending rates on the basis of which banks lend to customers will go up. A notable increase in the deposit rates offered by banks on fixed deposits for various maturities can be perceived.
An associated term is CRR or the cash reserve ratio. That is, the portion of deposits to be maintained by banks with the RBI. Increasing CRR pulls away excess money supply from the banking system. This reduces resources with banks and impacts its interest income. Hence, this usually leads to a rise in interest rates on loans like housing loans, that is passed on to borrowers in the longer run.
Times of India
A climb in inflation rates has always seen a frown on the foreheads of countless borrowers. Hike in inflation rate has often been succeeded by lenders hiking the interest rates on home loans. Banks have inserted clauses in their loan agreements that empower them to increase interest rates under special circumstances. And it is not only the floating but also fixed rate borrowers who have borne the brunt of increased rates.
So how does inflation impact home loans?
Inflation is the rise in general level of prices as against the purchasing power of the common man. Inflation in small doses is always considered healthy for an economy. Increasing prices and wages eliminates the need for negotiating and making downward price and wage adjustments that is usually associated with deflation. Inflation is a driving factor that motivates people to invest rather than save money over the longer run.
An out-of-control northward-bound inflation is detrimental to the economic fabric of a nation. When there is increase in money in circulation (government printing money in excess) when compared to the ability of the economy to supply, we see a demand-pull inflation. Then there is the cost-push inflation which can occur from certain events like scarcity of crude oil supply. Whatever be the cause, inflation hurts people, particularly those who have locked themselves in fixed instruments like the pensioners. Inflation can lead to a wage spiral where trade unions may demand more wages, and consequently industrial productivity will suffer.
Inflation can be reined by increasing interest rates. When the central bank hikes interest rates, it reduces money supply. This is the oldest method of controlling inflation. Increase in rates is associated with unemployment and fall in production that is immediately followed by a curb on unhindered price increase.
The Reserve Bank of India (RBI) is justified in increasing the repo and reverse repo rates to bring inflation under check. Repo rate is the benchmark rate at which the RBI lends to banks for a short term. All the banks that borrow money from the RBI have to bear this cost. Often used in conjunction with the repo rate is the reverse repo rate. When the RBI borrows money from banks against its securities, the interest rate at which it does so is known as reverse repo.
The reverse repo rate can also be defined as the return banks earn on excess funds parked with the central bank against Government securities.
When the RBI increases the repo rate, a natural fallout is an impending increase of the bank rate. This will soon snowball into hardening in interest rates - both lending and deposit rates. The lending rates or prime lending rates on the basis of which banks lend to customers will go up. A notable increase in the deposit rates offered by banks on fixed deposits for various maturities can be perceived.
An associated term is CRR or the cash reserve ratio. That is, the portion of deposits to be maintained by banks with the RBI. Increasing CRR pulls away excess money supply from the banking system. This reduces resources with banks and impacts its interest income. Hence, this usually leads to a rise in interest rates on loans like housing loans, that is passed on to borrowers in the longer run.
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