What Is Real, Nominal And Negative Real Interest Rates- Definition And Concept

Banking awareness is an important section and questions from this section do comes in banking and insurance exams. There are infact certain exams, where the entire section is dedicated to this subject. Considering the interview as well, there is no way, one can deny the importance of this section because as a banking aspirant, you are expected to have some basic knowledge about the banking and financial terms. In this space we will discussing three very important banking terms that you might have read many a times- Real Interest rate, Nominal Interest rate and Negative Interest rate. We will discuss them in detail.

Difference between Real Interest, Nominal and Negative Interest Rate?

Given below are some of the basic difference between these three widely used terms.

What is Real Interest Rate?

Real Interest rate refers to an interest rate that takes account of inflation and thus is adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower or investors. It is also signifacnt to reflect the real value yield to the lender or to an investor. When we subtract the inflation rate from the Nominal rate then we get Real Interest rate. Let’s Understand this concept with the help of an example: If someone wants to buy a house and he/she takes loan from bank at 3% rate of interest and at that point of time the inflation rate is 2% so basically Bank is receiving 1% interest rate which is real Interest rate.

What is Nominal Interest Rate?

Nominal Interest Rate refers to the rate of interest when we don’t take account of inflation. We tends to take the interest rate on its face value. This can be better understand with the help of an example– Ram wants to deposit his money in a bank and hence he went in a near bank branch. He asked the bank to deposit his money. Now, he will receive certain interest on it and this interest rate will be known as Nominal Interest rate because we are not considering the Inflation. With time, the power of money also decreases or increases and when don’t take that in account and just consider the interest rate given to us then that Interest rate is known as Nominal Interest Rate. 

In other words, if you have 100 Rupees and you are getting 5% interest rate on it then at the end of the year you will have 105 in your account and this is Nominal Rate Interest.

What is Negative Real Interest Rate?

Negative Real Interest Rate refers to the interest when inflation rate is higher than the interest rate. For example- If you have 100 rupees and you were getting 5% interest on it and the inflation is 8% so at the end of the year you will have to pay 108 to buy something from the market while you have only gain 105 rupees. In other words, Negative Real Interest Rate= Inflation Rate- Interest Rate.

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