Each bank loan increases the money supply in a fractional reserve banking system.
According to the quantity theory of money, a growing money supply increases inflation.
Thus, a low interest rate tends to result in more inflation.
High interest rates tend to lower inflation.
Does inflation have an impact on banking?
However high inflation leads to increased rate of interest and business people suffer as they have to pay higher rate of interest for their borrowings. The risk of loan default is more as inflation rises. Changes in rate of interest marginally affects banks as their spread is less.
How do banks benefit from inflation?
Inflation Helps Borrowers
A basic rule of inflation is that it causes the value of currency to decline over time. In other words, cash now is worth more than cash in the future. Thus, inflation lets debtors pay lenders back with money that is worth less than it was when they originally borrowed it.
How does inflation affect currency?
The higher the inflation, the less a currency is worth over time. The opposite is also true. Inflation represents the overall increase in the price of goods. Because the prices of goods are increasing, the same amount of money can buy less goods over time.
What is inflation in banking?
Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time. Often expressed as a percentage, inflation indicates a decrease in the purchasing power of a nation’s currency.