How are Interest Rates Determined?

My post about interest rates spurred another question by Kimberly: How are interest rates determined and why are they important?

The rate is determined usually by how much cash the bank can get, how much one is borrowing, and how quickly you promise to pay the bank back. It mostly depends though on you and how reliable you are in terms of paying the loan back. The lingo for this is, do you have “good credit”?

Interest is what drives all financial markets because the interest rates are the only reason why a bank is willing to lend businesses money. The fundamentals are there. Businesses can only operate if they stay profitable. Banks have access to money and have the ability to supply businesses with this commodity.

An example is if an ice cream store orders ice cream wholesale from a major manufacturer, they can buy the ice cream at a wholesale price and then must sell the ice cream as a profit to consumers. So if an ice cream cone costs $1 wholesale and the ice cream store charges consumers 3 dollars, the ice cream store is collecting a $2 profit margin.

Banks operate the exact same way, except they receive the profit in the terms of an interest rate. So going back to my $100 example, the bank can charge the consumer an additional 5% to get their $100 back as a cost of borrowing it from them.

Overall, interest rates are very fundamental to all major economies and are the thrusting force for what drives the global economies.