The terms Interest rate and Discount rate are both confusing as both are the charging rates. Most of the people misunderstood it as the same term. The Discount rate is the interest rate that the central bank gives to the commercial bank. The minimum interest rate offered is by the central bank.
And Interest rate here is the money or some other service that the lender gives to the borrower for that the lender charges some percentage of that money yearly or monthly as the interest rate. Both Interest rate and Discount rate are different as the Discount rate is imposed on big corporates and companies, while the Interest rate is for all example public and private sectors both.
Interest Rate vs Discount Rate
The main difference between the discount rate and Interest rate is that the Interest rate is the amount that is taken from the borrower yearly or monthly by the lender for the service they have provided. On the other hand, the Discount rate is a charge that the central bank imposes on the commercial banks on its shortest-term loans.
The interest rate is the amount taken from the borrower by the lender for the service they have provided. But the Interest rate is dependent on the effective rate of interest. The interest rate foists on an individual for personal use or corporates for public usage.
On the other hand, the Discount rate is a charge taken by the central bank to the commercial bank. It does not get affected by the effective rate of interest. And it calculates the current value of the net amount of cash that the commercial bank has returned.
Comparison Table Between Interest Rate and Discount Rate
| Parameters of Comparison | Interest Rate | Discount Rate |
| Definition | It is the loan that the lender gives to the borrower for that the lender charges some percentage of that amount yearly or monthly as the interest rate. | It refers to the interest rate that calculates the current value of the net amount of cash that the commercial banks return. |
| Dependency | It depends on the effective rate of interest. | It does not depend on the effective rate of interest. |
| Rates are decided by | Commercial banks. | Central bank. |
| Viewpoint | It is mainly focused on the lender’s viewpoint. | It is mainly focused on the investor’s viewpoint. |
| Uses | It is not used to calculate the net amount of cash that is returned by commercial banks. | It is used to calculate the net amount of cash that is returned by commercial banks. |
What is Interest Rate?
Interest rate is the money or some other service that the lender gives to the borrower for that the lender charges some percentage of that money yearly or monthly as the interest rate. It is charged monthly or annually depending on loan type and the amount loaned to the borrower. The interest rate relies on the effective interest rate. It shows that amount of loan depends on the reliability of the borrower.
Interest rates are decided by the Commercial banks, and it differs from bank to bank. There are two types of Interest rates one is Compound interest the other is Simple interest. Simple interest remains the same every year, but Compound interest changes as the amount charged previously are added to the principal amount.
What is Discount Rate?
The discount rate is the minimum interest rate that the central bank provides. It calculates the current value of the net amount of cash that the commercial banks return. In simple words, it is the amount that the central bank charges on the institutions or commercial banks on its shortest term loans as an interest. The discount rate does not depend on the effective rate of interest and is mainly concerned with the investor’s viewpoint. It does not differ from bank to bank.
In the Discount rate, the demand, supply, and value of the companies do not have any effect on Discount rates. In the Discount rate, the fixed amount of money plays different roles from time to time. It is usually charged to the investing institutions or commercial banks. The Discount rate does not get affected by the effective rate of interest.
Main Differences Between Interest Rate and Discount Rate
- The discount rate is the central bank’s interest rate on the commercial banks on its shortest-term loans. In contrast, interest is the loan that the lender gives to the borrower for that the lender charges some percentage of that money yearly or monthly as the interest rate.
- The interest rate is decided by the commercial banks, and the Discount rate is determined only by the central bank.
- The interest rate is affected by the change in the effective rate of interest. But the changes in the effective rate of interest do not affect the discount rate.
- In the Interest rate, the main focus is on the lender’s viewpoint, but in the Discount rate, the investor’s viewpoint is given more value.
- The discount rate is used to find the current value of the net amount of cash returned by the commercial banks. But it is not calculated by the Interest rate.
Conclusion
These terms might be confusing, but in simple language, the Discount rate is the amount that the central bank charges to the commercial banks on its shortest-term loans. And the Interest rate is the part of the amount credited which a lender charges as interest to the borrower. Usually, the Discount rate is foisted on big institutions to calculate the current value of the net amount of cash returned by the commercial banks.
The discount rate does not depend on the effective interest rate, but the Interest rate depends on the effective rate of interest and the value of the loan given to the borrower. The interest rate differs from bank to bank and the amount of loan issued to the borrower.
The discount rate focuses more on the investor’s viewpoint. And the Interest rate focuses more on the lender’s viewpoint. After all, the loan is provided by the lender.
References
- https://www.jstor.org/stable/1821281
- https://www.sciencedirect.com/science/article/pii/S0095069684710126