IMPACT OF INTEREST RATE FLUCTUATION
Author: Sakshi Patil
Interest Rate Fluctuations and Economic Stability
Kris & Goncalo, (2022) Presented the study utilizes quasi-experimental evidence from the first era of globalization to analyse how interest rates can stabilize economies external shocks. The findings indicate that countercyclical interest rates play a crucial role in stabilizing economies, particularly in commodity-exporting nations with fixed exchange rates. However, their impact is more pronounced in stabilizing price levels rather than GDP. Higher interest rates tend to reduce both output and prices. However, when interest rates follow a countercyclical pattern rising when export prices increase and falling when they decline, they help neutralize the impact of export-price shocks on GDP and inflation. This stabilization effect prevents excessive economic fluctuations, ensuring a more balanced and predictable macroeconomic environment.
Effects of Declining World Interest Rates on Economic Stability
Qiao, et al. (2020) Concluded When global interest rates decline, foreign debt, capital, output, and financial leverage increase, while the current account-to-output ratio deteriorates due to rising capital inflows. Larger interest rate shocks further amplify economic fluctuations, creating greater instability. Among macroprudential policies, limiting excessive foreign borrowing through liability-side measures effectively stabilizes key economic variables, whereas restricting banks’ total asset expansion on the asset side proves less effective. Empirical data from both emerging and advanced economies confirm surges in capital inflows during ultra-low-interest rate periods, aligning with model predictions, though some regional variations exist.
Interest Rate Dynamics and Their Impact on Banking and Economic Growth
Luminita, et al. (2016) Emphasized the Interest is the price of capital used or the “rent” paid by the debtor for the right to utilize borrowed funds. The interest rate level is generally correlated with the profit rate earned by entrepreneurs, influencing credit demand and supply. A low interest rate increases credit demand, stimulating production and economic growth, whereas a high cost of credit reduces borrowing. Banks play a crucial role in financing industries, construction, agriculture, services, and trade, helping companies enhance product quality, expand operations, and align with market demands, ultimately reducing macroeconomic imbalances, especially in developing economies. However, banks face interest rate risks due to market fluctuations, impacting the value of assets and liabilities. Banks also analyse economic cycles carefully, avoiding high-growth but unsustainable sectors, and focus on securing investments by requiring additional collateral or government-backed securities to mitigate credit risk.
The Relationship Between Interest Rates and Bank Funding Costs in South Africa
Azasakhe & Roscoe, (2018) Stated that the effect of short-term interest rates on bank funding costs in South Africa, highlighting a significant positive long-term relationship between short-term interest rates, long-term interest rates, capital-to-asset ratio, and GDP growth. Contrary to expectations, GDP growth exhibited a positive relationship instead of a negative one. When interest rates rise, banks must pay higher returns to depositors, increasing their funding costs. the impact of short-term interest rates on bank funding costs in South Africa. Variance decomposition analysis confirms that short-term interest rate fluctuations are the primary driver of bank funding cost shocks over time. The identified a positive relationship between interest rates and bank funding costs, as well as pass through effects from lending rates to funding rates. The findings indicated a significant positive long-term relationship between short-term interest rates, long-term interest rates, the capital to asset ratio.
Impact of Interest Rate Fluctuations on Bank Profitability
Afzal, et al. (2018) Presented the impact of interest rate fluctuations on the financial performance of banks in Pakistan. It identifies key profitability measures Return on Assets (ROA), Return on Equity (ROE), and Earnings per Share (EPS) and their relationship with factors such as deposits with other banks, interest rates, advances & loans, and investments. Findings indicate that increased deposits with other banks lower ROA, while investments and advances positively impact profitability. Interest rates negatively affect ROA and ROE, as lower rates reduce bank assets due to decreased deposits, while higher rates encourage savings, increasing profitability. EPS is significantly influenced by these factors, with investments and advances boosting earnings, while deposits with other banks and interest rates have an inverse effect.
Impact of Interest Rates on Earnings Quality in Iraq’s Financial Sector
Salman & Diyar, (2024) Concluded Earnings quality is a fundamental aspect of financial reporting, signifying the extent to which earnings reflect a company’s true financial performance. Fluctuations in interest rates significantly impact the financial performance of firms in the financial services sector, affecting key fiscal metrics such as net interest margins, loan demand, and asset valuations. Rising interest rates can widen margins but may reduce loan demand, while falling rates can compress margins and increase the risk of poor-quality loans. Interest rate movements also influence consumer behaviour, business investment, and economic stability. The study explores the impact of fluctuating interest rates on earnings quality in Iraq’s financial services sector, with findings indicating a positive relationship between interest rate changes and Net Interest Margin (NIM).
Understanding the Link Between Interest Rates and Stock Market Volatility
Albert, (2024) Emphasized Stock market volatility, often measured by the VIX Index or standard deviation of stock returns, serves as a key indicator of market uncertainty and investor sentiment. Developing economies experience higher volatility due to economic instability, political uncertainty, and lower market liquidity. Studies indicate that interest rate changes significantly impact stock market volatility, with both immediate and long-term effects. Short-term volatility spikes often follow interest rate announcements, particularly in rate-sensitive sectors, while long-term effects depend on market conditions and investor sentiment. Unexpected rate changes lead to sharper volatility compared to anticipated shifts, emphasizing the role of market expectations and risk management. Additionally, interest rate fluctuations create spillover effects across global markets, requiring a broader risk assessment approach. The complex interplay between interest rates and stock market volatility underscores the need for further research to provide insights for investors, policymakers, and market participants in managing market risks effectively.
Challenges and Financial Constraints Affecting SME Growth in Ghana
Kwame, (2017) Presented Small and Medium Enterprises (SMEs) play a vital role in economic development. The study highlights the strong interdependence between SME profitability, interest rates, bank loans, and business size. It finds a positive relationship between profitability, interest rates, and capital structure but a negative relationship with business size. High profitability is associated with high interest rates and increased loans but limited business growth. SMEs are crucial to Ghana’s economy, yet their growth is hindered by limited access to finance due to factors like lack of collateral, stringent loan criteria, and high interest rates. These challenges restrict their ability to secure necessary funding for expansion and operations. It suggests empowering SMEs through formal and informal entrepreneurship education to enhance their managerial skills and creditworthiness, with training certificates as a loan prerequisite.
The Impact of Interest Rates on Cattle Production Costs and Profitability
Griffith, (2023) Stated that Interest rates play a crucial role in determining production costs in the cattle business, especially for operations that rely on borrowed capital. Higher interest rates and cattle prices increase the overall cost of production by raising interest expenses per animal, while lower rates and prices reduce costs, improving profitability. The actual interest rates faced by producers depend on various factors, including credit score, loan terms, and economic conditions. Given the impact of fluctuating interest rates, cattle producers must carefully consider interest expenses and associated risks when making purchasing decisions to maintain sustainable profit margins
Interest Rate Risk Management in German Banks
Memmel, (2019) Presented short-term fluctuations in German banks. The findings indicate that banks actively manage their interest rate risk using instruments like interest rate swaps and adjust their exposure based on changes in remuneration. Additionally, banks exceeding a regulatory threshold for interest rate risk tend to reduce their exposure in the quarter. However, the study also reveals that the fixed-interest period of housing loans is primarily determined by customers, not banks, impacting overall interest rate risk exposure. This suggests that banks do not fully mitigate the additional risk arising from loan granting. Interest rate risk is often considered a market risk contributing significantly to bank earnings
Conclusion
Interest rate fluctuations significantly impact economic stability, banking profitability, financial markets, and industries. Countercyclical interest rates help stabilize economies by mitigating external shocks, particularly in commodity-exporting nations, while declining global rates increase financial instability due to rising capital inflows and foreign debt in the banking sector. interest rate changes influence credit demand, bank funding costs, and profitability, with lower rates stimulating lending but exposing banks to risk. Additionally, interest rate movements affect stock market volatility, SME growth, and industry-specific costs, such as cattle production expenses, requiring businesses and financial institutions to adapt through effective risk management and policy measures.
References
Afzal Ahmed & Raja Rehan & Imran Umer Chhapra & Saima Supro, 2018. “Interest Rate and Financial Performance of Banks in Pakistan,” International Journal of Applied Economics, Finance and Accounting, Online Academic Press, vol. 2(1), pages 1-7.
Albert Katembo, 2024. “Effect of Interest Rate Changes on Stock Market Volatility in Congo,” American Journal of Finance, AJPO, vol. 10(3), pages 1-12.
Azasakhe Nkcubeko Nomsobo & Roscoe Bertrum van Wyk, 2018. “The Impact of Short- Term Interest Rates on Bank Funding Costs,” Journal of Economics and Behavioral Studies, AMH International, vol. 10(3), pages 141-148.
Griffith, Andrew P., 2023. “Interest Rates Impact Cattle Cost of Production,” Extension Reports 337152, University of Tennessee, Department of Agricultural and Resource Economics.
Kris James Mitchener & Gonçalo Pina, 2022. “Causal Effects of Countercyclical Interest Rates: Evidence from the Classical Gold Standard,” CESifo Working Paper Series 9716, CESifo.
Kwame Godsway Kisseih, 2017. “The Impacts of Interest Rate Fluctuations on the Growth of Small and Medium Enterprises (SMEs) In Accra,” International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 7(2), pages 44-53, April.
Luminita Gabriela ISTRATE & Bogdan Stefan IONESCU & Maria-Monica HARALAMBIE, 2016. “Aspects of the impact of interest rate development on the probability of default,” The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 14(142), pages 1149-1149, October.
Memmel, Christoph, 2019. “What drives the short-term fluctuations of banks’ exposure to interest rate risk?,” Discussion Papers 05/2019, Deutsche Bundesbank.
Qiao Wang & Haizhen Yang & Xiangjuan Cheng, 2020. “Impact of Global Low Interest Rates to the Capital Flows and Financial Vulnerability of Small Open Economies,” Asian Economic and Financial Review, Asian Economic and Social Society, vol. 10(4), pages 449-468.
Salman Beik Boshrouyeh & Diyar Abdulmajeed Jamil, 2024. “Assessing earnings quality metrics and the impact of interest rate fluctuations in the financial services sector in the Iraq stock market,” Edelweiss Applied Science and Technology, Learning Gate, vol. 8(6), pages 8667-8681.
