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Prime rate, or Prime Lending Rate, is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case. Some variable interest rates may be expressed as a percentage above or below prime rate.

Contents

Use in different banking systems

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USA and Canada

Historically, in North American banking, the prime rate was the actual interest rate although this is no longer the case. The prime rate varies little among banks, and adjustments are generally made by banks at the same time, although this does not happen with frequency. The prime rate is currently 3.25% in the United States.[1] Canadian prime rate is currently 2.25%.[2]

Overview

Historical chart of the effective Federal Funds Rate

In the US, the prime rate runs approximately 300 basis points (or 3 percentage points) above the federal funds rate, the interest rate that banks charge to each other for overnight loans made to fulfill reserve funding requirements. The Federal funds rate plus a much smaller increment is frequently used for lending to the most creditworthy borrowers today, as is LIBOR, the London Interbank Offered Rate. The Federal Open Market Committee (FOMC) meets eight times per year wherein they set a target for the federal funds rate. Other rates, including the prime rate, derive from this base rate.

When 23 out of 30 of the United States' largest banks change their prime rate, the WSJ prints a composite prime rate change.

Malaysia

Banks in Malaysia and some other countries use the name Base Lending Rate to refer to their prime rate. Base Lending Rate (BLR) is a minimum interest rate calculated by financial institutions based on a formula which takes into account the institutions cost of funds and other administrative costs. The BLR is almost always the same amongst major banks. Adjustments to the BLR are made by banks at almost the same time; although, the BLR does not adjust on any regular basis. The BLR is usually adjusted at the time in correlation to the adjustments of the Overnight Policy Rate (OPR) which is determine by Bank Negara Malaysia (BNM) during Monetary Policy Meeting.

Uses

The prime rate is used often as an index in calculating rate changes to adjustable rate mortgages (ARM) and other variable rate short term loans. It is used in the calculation of some private student loans. Many credit cards and home equity lines of credit with variable interest rates have their rate specified as the prime rate (index) plus a fixed value commonly called the spread or margin.

See also

References

  1. ^ According to data published by The Wall Street Journal Online and the Federal Reserve Bank. "Federal Reserve Statistical Data". Federal Reserve. http://www.federalreserve.gov/releases/h15/data/Monthly/H15_PRIME_NA.txt. 
  2. ^ According to data published by Bank of Canada. "Daily Digest- Rates and Statistics- Bank of Canada". Bank of Canada. http://www.bankofcanada.ca/en/rates/digest.html. 

External links


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