Interest rate charged is the reward for taking the risk on the capital. Interest rate is often referred to as the “cost of funds” or hurdle rate.
Risk to Capital
If the lender perceives a higher default risk on capital lent out, the higher the interest demanded. The causes to credit risks can come from shocks to the financial system from within the country or beyond. As the world’s financial systems are increasingly interlinked, any credit event far away can increase potential default risk.
Demand for funds
The increased demand for funds when it outstrips the supply will also cause interest rates to rise. Genuine demand of funds comes from the industry’s need for investment. Industry will borrow money for investments if they think their investments returns can better the interest rate. This type of capital demand can help a country increase its productive capacity. The other types …