What are Basis Points?

Basis points also abbreviated as BPS, is value used in the financial sector to describe the change in the rate of interest of various financial instruments. One basis point is equal to one-hundredth of a percent or you can say 1 bps is equal to 0.01%. In other terms if you say 100 bps is equal to 1% representing a fraction of a percent in neither decimal nor percentage.

How to Calculate BPS or Basis Points?

As we know, one basis point is equal to 0.01% or 0.0001 in decimal form while 100 BPS is equal to 1%. If the value is in basis point, then it’s ok, if it’s in percentage, then to change basis points to a percentage or vice versa, you need to divide or multiply it by 100.

Let’s take an example to help you understand how to calculate BPS.

Suppose the interest rates on deposits by your bank is increased by 150 basis point, then how will you convert this into the percentage to calculate the new interest rates.

1 Basis Points = 0.01% or (1÷ 100 = Percentage)

150 Basis points = 1.5% (150 ÷ 100)

Suppose you currently earning 6% interest on your deposits, and now 150 basis point increased by the bank, then new interest rate will be 7.5% (6%+1.5%).

How to Convert Basis Points into Percentage?

Calculating the BPS would be not difficult but many times using this into your financial calculation becomes confusing. Hence, you can simply convert the BPS into the percentage. Here below you can find how to convert the bps into percentage.

Step 1: Take the number showing into the basis point.

Step 2: Now divide the same by 100.

Step 3: The value comes into the percentage

For an example, if you have 200 basis points, just divide the same with 100, it becomes 2% that is easier to understand but still basis points are used in financial sector.

Why Use Basis Points Instead of Percentage?

You may find it confusing but financial experts or people dealing in the financial sector, especially from the banking sector are using this term very often in their day-to-day professional life. Hence, as per the financial experts, basis points are used instead of percentages because they find it less ambiguous as it shows an absolute, set figure instead of a ratio.

Apart from this, BPS provides measurement that is more precise especially when we talk about the small changes in interest rates or yields on other financial metrics. Moreover, using this terminology also helps to avoid the ambiguity especially when we discuss about change in interest rates.

And one of the most important reasons of using the basis points instead of percentage is because of financial markets. In this market, most of the financial or investable instruments and their yield matrices are expressed in basis points to create a standard language that everyone working into this industry can easily understand and use in the professional life.

Financial Instruments where BPS is mainly used:

Bonds: The bps is most and very often used in the bond market, it is either treasury bonds or corporate bonds. The bonds issued by the government or corporate bodies are usually priced in the basis point to show the interest rates given to bond holders. And to calculate the bond yield or analyse any change like increase, or decrease in the interest rate bps is used.

Loan and Credits: The change in the interest rates for lending is measured in basis points by central bank, commercial banks and all financial institutions. This includes interest rates on home loan, personal loan and credit cards, where basis points are used to represent the changes in interest rates.

Investable Instruments: The investable instruments like fixed deposits, mutual funds schemes and ETFs sold by banks, financial institutions or assets management companies all shows the rate of interest in terms of basis points.

Derivatives Market: Apart from the above said financial instrument, the BPS is also used in future and options that is also called derivatives market. The change in rate of returns or adjustment in future and options contracts are also quoted in basis points.

Importance of Basis Points in Banking & Finance

In financial world, using the basis points is a universal language, helps the users to clearly define the minor changes in the interest rates with higher accuracy. In our economy, basis point are used to measure the rate of return on various financial instruments. Even small changes in these returns can directly or indirectly influence the individuals financial decisions.

In the life of normal people, the change in BPS can affect the cost of borrowing funds or have impact on the interest earned on savings and other types of deposits. It may have impact on mortgages and various types of loan and advances influencing the spending done by the consumers that directly and indirectly also affect the growth of the economy. Using BPS in financial world has its importance, let’s find out few points why it matters.

Precise Calculation: Even the minor changes upto three decimals can be calculated and represented through BPS. And in financial world even a minor changes can mean a lot especially in terms of money when value or amount is very high. BPS provides more precise calculations with accuracy.

Reduce Ambiguity: Using the BPS provides you more clear picture while understanding about the change in the rates. A change of 100 bps is 1% change, but a 150 basis points change might be confusing whether it is 1.5% or 0.15%. Using bps here, reduce the ambiguity in percentage changes.

Easy to Compare: While choosing the investment plans or buying the ETFs or mutual fund schemes using bps instead of percentage makes easier to differentiate the rate of returns.

Standardized Tool: One of the key advantages of using the bps is that it provides a universal standard for the financial sector to easily measure percentage changes.

Summing-up

Basis points represent one hundredth of a  percent. To convert bps into a percentage, divide the value in bps by 100 and to convert a percentage into bps just multiply the value by 100. It is mainly used in the financial market especially while calculating the rate of return on bonds, loans, deposits and various financial derivative instruments.

Using the BPS in the financial world is very important to make it easy to understand even minor changes in interest rates with more precision. Apart from this, it also eliminates ambiguity and provides standardization with a universal language to all the participants. It directly and indirectly affects the financial decisions of people in an economy when there are changes in interest rates on loans, advances, credits, deposits and financial instruments.