RBI, which is the statutory body to maintain currency exchange rates and money supply in the economy uses various tools to keep an eye on these. Interest rate is one such measure that is decided by RBI to maintain steady liquidity in the economy. Interest can be paid in an equated monthly or quarterly or annual installments. This transaction can be between any two parties like
- Commercial Bank and RBI
- Between two commercial banks
- Insurance company and a policyholder.
- Loan holder and bank
- Customer’s bank account with a specific bank.
As mentioned above these types of transactions either charge interest or give interest. Some interest rates that banks look forward to are the repo rate and reverse repo rates. When there are surplus funds in the circular flow of the economy then RBI increases the repo rate to control the money supply and when there is the contraction of monetary flow, RBI decreases the repo rate and allows the economy to come to the level of enough liquidity. The same is with the Reverse repo rate when there is a cash crunch in the system RBI increases the reverse repo rate, however when there is excess cash then the Reverse repo rate will be decreased by RBI. These interest rates are of high use by the banks. The interest rates useful for the common public are home loan rates, FD rates.
Interest rates are very beneficial for small-cap investors because a slight change in interest rate can cause a change in the whole capital structure. When an investor has a very diversified portfolio so that the risk associated is also minimized and if there are some securities that give high interest and some give low interests then it can get stable.