This blog post explores how interest rate hikes impact our lives, examining who gains and who loses in an easy-to-understand and engaging way.

Key Concepts

Interest Rate

Refers to the interest or rate applied to borrowed or deposited money. Think of it as a usage fee paid for borrowing money. Also called the ‘interest rate’, it is determined based on the amount of principal.

Base Rate

The benchmark interest rate set by the government to manage the money supply and the economy. It is determined by each country’s central bank; in Korea, it is managed by the Bank of Korea.

Net Interest Margin

The interest profit banks earn based on the difference between deposit rates and loan rates.

Monetary Policy

A policy that increases or decreases the amount of money flowing in the market to maintain an appropriate level. It is a tool used by central banks to manage the overall flow of the economy by adjusting the base rate.

When borrowing money, you must pay a usage fee!

Interest is the cost you must pay to use ‘money’. Think of money as an object. When we rent a bicycle to ride, we pay money. The money paid then is called a usage fee or (rental) cost. That amount is usually charged by the hour, like ‘1,000 won per hour’. Now, let’s replace the bicycle with money. When borrowing money, you pay a usage fee just like when renting a bicycle. Generally, the period for borrowing and using money is set in years. The usage fee paid for borrowing and using money for one year is the interest rate.

How is interest determined?

Interest rates are also called interest rates, and there’s a reason the word ‘rate’ is used. This is because the usage fee is determined proportionally to the size of the ‘item borrowed for use (principal)’. This is the difference between borrowing a bicycle and borrowing money. When borrowing a bicycle, you borrow a whole one; no one borrows just one wheel. Therefore, the bicycle rental company sets a fixed usage fee per bicycle and charges based on the number rented. Money is different. You can borrow $100 or $1,000. If using an overdraft account, you can even borrow $1. Since the amount borrowed is flexible, the usage fee is set as a percentage of the principal amount. Thus, the precise definition of interest is ‘the usage fee ratio based on the principal amount’.
People often say they ‘deposit’ money when putting it in a bank. After a certain period (usually one year), the bank pays interest to the depositor. That’s why people often compare interest rates before depositing. It’s natural to deposit money and receive interest. However, as mentioned earlier, interest is a usage fee for money. Who uses the money I deposited and pays the usage fee? The bank. The bank pays the customer a usage fee, i.e., interest, as compensation for using the money the customer deposited. Doesn’t the bank lose money in this process? No. The bank lends money to people at a higher interest rate and pockets the difference. This profit is called the ‘net interest margin’.

Deposit and Loan Interest Rates Must Be Viewed Together
Largest Deposit-Loan Interest Rate Gap in 8 Years… Concerns Grow Over Banks’ ‘Interest Arbitrage’ (Newsis, November 28, 2022)

The deposit interest rate is the rate paid when depositing money in a bank, while the loan interest rate is the rate charged when borrowing from a bank. These are collectively referred to as the deposit-loan interest rate. The deposit and loan rates are so closely linked that they are often grouped together. The deposit-loan interest rate spread refers to the difference between these rates, and the interest margin denotes the profit derived from this spread. The headline of the article uses the phrase ‘concerns over banks profiting from interest rates,’ implying that the current situation favors banks and disadvantages those depositing or borrowing money.
Suppose the deposit rate is 5% and the loan rate is 10%. The bank pays depositors 5% interest on the amount deposited and charges borrowers 10% interest on the amount loaned. The difference between the deposit and loan rates is 5%. That 5% amount is the bank’s profit.
As mentioned earlier, economic articles can be interpreted differently depending on the reader’s situation and perspective. Seeing the example above, one might react with, “The bank is making a lot of money, huh?” From a bank employee’s perspective, they might think, “Maybe we’ll get a bonus?” What about the bank’s customers? Whether they’re looking to deposit or borrow, they might both say, “Isn’t the bank just getting rich?” But the meaning behind this statement differs slightly depending on their position. For someone looking to deposit, it means the deposit rate is too low. For someone looking to borrow, it means the loan rate is too high.
That doesn’t mean the bank is making money unfairly. To attract deposits, they must run promotions. They must verify borrowers’ repayment capacity beforehand. They must cover losses from unrepaid loans. Handling all these tasks in the middle means earning a reasonable profit is only natural.
When interest rates rise for any reason, money naturally floods into banks’ savings products (deposits or savings accounts). Consider this article headline:

High-Interest Deposits Attract 56 Trillion Won in Lump-Sum Funds in One Month… Banks’ ‘Low-Cost Deposits’ Left Cold (Maeil Business Newspaper, November 28, 2022)

Whether banks raise deposit rates or the government raises the base rate, when interest rates increase, people invest more money in deposits and savings accounts. However, we see the somewhat unfamiliar term ‘low-cost deposits’. Low-cost deposits refer to deposits that cost banks less to collect (i.e., fund). They are also called ‘demand deposits’ or ‘checking accounts’. The name might not be familiar, but it’s actually a product we all use. The regular checking account where your salary is deposited or your credit card payments are deducted (also called a ‘savings account’) is precisely a demand deposit or a passbook savings account. The defining feature of this deposit is that the bank must return the money to the depositor whenever requested, without any conditions. While other fixed-term deposits and savings accounts also allow withdrawals anytime the account holder wishes, doing so forfeits the originally promised interest. Demand deposits offer relatively very low interest rates. Since fixed-term deposits offer higher rates, no one would keep money in a low-interest product indefinitely, hence the description in the previous article of it becoming a ‘cold dish’. As the popularity of low-interest deposits plummeted, they’ve recently been repackaged and rebranded as ‘parking accounts’. The name comes from the idea of parking money, meaning you can deposit and withdraw it frequently. Functionally, they are the same as demand deposit accounts, but they are classified as ‘parking accounts’ if the interest rate is high and ‘demand deposit accounts’ if it is low.

High interest rates divide reality… Wealthy earn more, borrowers pay more (Newsis, 2022.11.17.)

If you come across an article about deposit rates rising, it means it’s time to pay attention to deposit products. Simultaneously, it signals the need to observe long-term whether rates will continue to rise or fall. When rates keep rising, you should consider shifting money invested in real estate or stocks elsewhere.
Typically, rates move in tandem. When deposit rates rise, loan rates normally follow. Loan rates have a greater impact on the overall economy and daily life. Higher deposit rates increase banks’ expenses, putting them in a difficult position; at such times, banks may lower deposit rates. However, when loan rates rise, households and businesses have no means to lower them. They must simply bear the increased burden and find ways to repay the debt. The article coldly expressed this ‘reality’ using the word ‘reality’: while rising interest rates offer asset holders the opportunity to earn more interest, for those with loans, it means the pain of having to repay more money.