Falling Base Rate of commercial banks; What it means for investors

Although banks have a wide variety of products and responsibilities, their primary function is to accept deposits and release loans. Basically, banks make money by charging a pre-specified interest rate for the money it lends. On the other hand, it gets the money to lend by encouraging savers to deposit their cash in return for a certain extra interest payment.

It is a known fact that banks charge higher interest rates while we borrow money than the rate it pays us if we deposit our cash. While this is for a variety of reasons, the primary reason is that banks have to be liquid at all times.

Banks cannot lend all the deposits to borrowers. If this happens, banks cannot pay back the savers on time if they demand a withdrawal. For this reason, some capital has to be kept for liquidity. To overcome the loss that this creates, banks have to charge a higher rate for the limited capital they lend.

How do banks determine their interest rates? Why are the rates different for different savings and credit packages?

This leads us to an interesting instrument that banks use, which is called the base rate.

The base rate is the minimum rate banks have to charge to their customers to remain in profit. It is calculated on the basis of expenses incurred by the banks and financial institutions as cost of funds, cost of liquidity (CRR and SLR), cost of operation.

Banks will adjust interest rates for different instruments they have by adding to the base rate. It all depends on what kind of lending they want to encourage and what kind of lending they think is risky for their capital.

Banks have revised their interest rates along with the base rates in recent days. Sharesansar compared the change in their base rates. The findings are tabulated below:

What impact will a decreased base rate have on the stock market?

Needless to say, a smaller interest rate means better access to capital. More people will be encouraged to borrow money from banks if they have to pay lesser as interest. Investors can take loans against shares to reinvest in financial securities without much worry.

More liquidity equals more opportunity in the stock market. NEPSE is very likely to witness a surge in the volume of transactions if people choose to invest their liquid capital in shares.

Moreover, a reduced interest rate discourages the general public from keeping their cash idle at a deposit account. They might want to enter the stock market for better returns instead.