Table of Contents

 What Is the Prime Rate?

 How It Works
 Determining the Prime Rate
 Impact
 Prime Rate FAQs
 The Bottom Line

 MONETARY POLICY  
 INTEREST RATES

What Is the Prime Rate?

By 
JAMES CHEN
 

Updated September 09, 2022

Reviewed by 
MICHAEL SONNENSHEIN




What Is the Prime Rate?

The prime rate is the interest rate that commercial banks charge their most creditworthy
customers. The Federal Reserve sets the federal funds overnight rate which serves as the basis
for the prime rate, the starting point for other interest rates.

KEY TAKEAWAYS

 The prime rate is the interest rate that commercial banks charge their most creditworthy
corporate customers.
 Banks generally use a "fed funds + 3" to determine the current prime rate.
 The rates for mortgages, small business loans, and personal loans are based on the prime
rate.
 The most used prime rate is the rate that the Wall Street Journal publishes daily.
Prime Rate

Understanding the Prime Rate

The prime rate is the interest rate that commercial banks charge their most creditworthy
customers, generally large corporations. The prime interest rate, or prime lending rate, is largely
determined by the federal funds rate, which is the overnight rate that banks use to lend to one
another.

The rate forms the basis or starting point for most other interest rates, including rates for
mortgages, small business loans, or personal loans.

Interest rates charged by banks and lenders act as compensation for the risk assumed by the
lender based on the borrower’s credit history and other financial details.

 
The Prime Rate plus a percentage forms the base of almost all other interest rates.

Determining the Prime Rate

The prime rate is an interest rate determined by individual banks and used as a base rate for
many types of loans, including loans to small businesses and credit card loans. Although the
Federal Reserve has no direct role in setting the prime rate for banks, many institutions choose to
set their prime rates based partly on the target level of the federal funds rate established by
the Federal Open Market Committee.

Federal Funds Rate

The federal funds rate is the interest rate at which depository institutions trade funds held at
Federal Reserve Banks with each other overnight. When a depository institution has surplus
balances in its reserve account, it lends to other banks in need of larger balances.
One of the most used prime rates is the one that the Wall Street Journal publishes daily. Banks
generally use a "fed funds + 3" to determine the current prime rate. As of July 28, 2022, the
current prime rate is 5.50% in the U.S., and the federal funds rate is currently 2.25% to 2.50%.1

Although other U.S. financial services institutions regularly note any changes that the Federal
Reserve (the Fed) makes to its prime rate, and may use them to justify changes to their prime
rates, institutions are not required to raise their prime rates following the Fed.2

What Is the Impact of the Prime Rate?

The prime rate affects a variety of bank loans. When the prime rate goes up, so does the cost to
access small business loans, lines of credit, car loans, mortgages, and credit card interest rates.
Debt with a variable interest rate can be affected by the prime rate because a bank can change
your rate. This includes credit cards as well as variable rate mortgages, home equity loans,
personal loans, and variable rate student loans.

The prime rate is reserved for only the most qualified customers, those who pose the least
amount of default risk. Prime rates may not be available to individual borrowers but are offered
to larger entities, such as corporations and stable businesses. If the prime rate is set at 5%, a
lender still may offer rates below 5% to well-qualified customers which are not considered a
mandatory minimum.

How Has the Prime Rate Changed Over Time?

Prime rates fluctuate over time depending on the movement of the federal funds rate. The most
recent prime rates were:

7/28/22: 5.50%

6/16/22: 4.75%

5/5/22: 4.00%

3/17/22: 3.50%

3/16/20: 3.25%3

What Is Not Affected by a Change in the Prime Rate?

Any existing loan or line of credit held with a fixed rate is not affected by a change in the prime
rate. This may include student loans, fixed-rate mortgages, and savings accounts.

What Does a Change in the Prime Rate Signal?

A change in the prime rate often means that the Federal Reserve has changed its fund rate. For
example, an increase to the federal funds rate may be to fight growing inflation and control price
growth.

The Bottom Line

The prime rate is the interest rate that commercial banks charge creditworthy customers and is
based on the Federal Reserve's federal funds overnight rate. Banks generally use a "fed funds +
3" to determine the current prime rate. The rate forms the basis for other interest rates, including
rates for mortgages, small business loans, or personal loans.
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Related Terms
Federal Funds Rate: What It Is, How It's Determined, and Why It's Important
The federal funds rate is the target interest rate set by the Fed at which commercial banks
borrow & lend their extra reserves to one other overnight.
 more
ARM Index
An ARM index is what lenders use as a benchmark interest rate to determine how adjustable-
rate mortgages are priced.
 more
Prime
Prime is a classification of borrowers, rates, or holdings in the lending market that are
considered to be of high quality.
 more
What Is the Wall Street Journal Prime Rate?
The Wall Street Journal Prime Rate is an average of 10 banks' prime rates on short-term loans
and published in WSJ.
 more
Variable-Rate Certificate of Deposit (CD)
A variable-rate certificate of deposit is an investment product with relatively low risk, but it also
possesses an interest rate that can fluctuate.
 more
Subprime Loan
A subprime loan is a loan offered at a rate above prime to individuals who do not qualify for
prime-rate loans.
 
Table of Contents

 What Is a Repurchase Agreement?

 Understanding Repurchase Agreements
 Term vs. Open Repurchase Agreements
 The Significance of the Tenor
 Types of Repurchase Agreements
 Near and Far Legs
 The Significance of the Repo Rate
 Risks of Repo
 The Financial Crisis and the Repo Market

 BONDS  
 FIXED INCOME

Repurchase Agreement (Repo): Definition,

Examples, and Risks
By 
NATHAN REIFF
 

Updated June 18, 2022

Reviewed by 
GORDON SCOTT
Fact checked by 
TIMOTHY LI

Investopedia / Katie Kerpel

What Is a Repurchase Agreement?

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government
securities. In the case of a repo, a dealer sells government securities to investors, usually on an
overnight basis, and buys them back the following day at a slightly higher price. That small
difference in price is the implicit overnight interest rate. Repos are typically used to raise short-
term capital. They are also a common tool of central bank open market operations.
For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the
party on the other end of the transaction, buying the security and agreeing to sell in the future, it
is a reverse repurchase agreement.

KEY TAKEAWAYS

 A repurchase agreement, or 'repo', is a short-term agreement to sell securities in order to

buy them back at a slightly higher price.
 The one selling the repo is effectively borrowing and the other party is lending, since the
lender is credited the implicit interest in the difference in prices from initiation to
repurchase.
 Repos and reverse repos are thus used for short-term borrowing and lending, often with a
tenor of overnight to 48 hours.
 The implicit interest rate on these agreements is known as the repo rate, a proxy for the
overnight risk-free rate.

Repurchase Agreement

Understanding Repurchase Agreements

Repurchase agreements are generally considered safe investments because the security in
question functions as collateral, which is why most agreements involve U.S. Treasury bonds.
Classified as a money-market instrument, a repurchase agreement functions in effect as a short-
term, collateral-backed, interest-bearing loan. The buyer acts as a short-term lender, while the
seller acts as a short-term borrower.1 The securities being sold are the collateral. Thus the goals
of both parties, secured funding and liquidity, are met.

Repurchase agreements can take place between a variety of parties. The Federal Reserve enters
into repurchase agreements to regulate the money supply and bank reserves. Individuals
normally use these agreements to finance the purchase of debt securities or other investments.
Repurchase agreements are strictly short-term investments, and their maturity period is called the
"rate," the "term," or the "tenor."1

Despite the similarities to collateralized loans, repos are actual purchases. However, since the
buyer only has temporary ownership of the security, these agreements are often treated as loans
for tax and accounting purposes. In the case of bankruptcy, in most cases repo investors can sell
their collateral. This is another distinction between repo and collateralized loans; in the case of
most collateralized loans, bankrupt investors would be subject to an automatic stay.
Term vs. Open Repurchase Agreements
The major difference between a term and an open repo lies in the amount of time between the
sale and the repurchase of the securities.

Repos that have a specified maturity date (usually the following day or week) are term
repurchase agreements. A dealer sells securities to a counterparty with the agreement that they
will buy them back at a higher price on a specific date. In this agreement, the counterparty gets
the use of the securities for the term of the transaction, and will earn interest stated as the
difference between the initial sale price and the buyback price. The interest rate is fixed, and
interest will be paid at maturity by the dealer. A term repo is used to invest cash or finance assets
when the parties know how long they will need to do so.2

An open repurchase agreement (also known as on-demand repo) works the same way as a term
repo except that the dealer and the counterparty agree to the transaction without setting the
maturity date. Rather, the trade can be terminated by either party by giving notice to the other
party prior to an agreed-upon daily deadline. If an open repo is not terminated, it automatically
rolls over each day. Interest is paid monthly, and the interest rate is periodically repriced by
mutual agreement. The interest rate on an open repo is generally close to the federal funds rate.
An open repo is used to invest cash or finance assets when the parties do not know how long
they will need to do so. But nearly all open agreements conclude within one or two years.2

The Significance of the Tenor

Repos with longer tenors are usually considered higher risk. During a longer tenor, more factors
can affect repurchaser creditworthiness, and interest rate fluctuations are more likely to have an
impact on the value of the repurchased asset.1

It's similar to the factors that affect bond interest rates. In normal credit market conditions, a
longer-duration bond yields higher interest. Long-term bond purchases are bets that interest rates
will not rise substantially during the life of the bond. Over a longer duration, it is more likely that
a tail event will occur, driving interest rates above forecasted ranges. If there is a period of
high inflation, the interest paid on bonds preceding that period will be worth less in real terms.

This same principle applies to repos. The longer the term of the repo, the more likely that the
value of the collateral securities will fluctuate prior to the repurchase, and business activities will
affect the repurchaser's ability to fulfill the contract. In fact, counterparty credit risk is the
primary risk involved in repos. As with any loan, the creditor bears the risk that the debtor will
be unable to repay the principal. Repos function as collateralized debt, which reduces the total
risk. And because the repo price exceeds the value of collateral, these agreements remain
mutually beneficial to buyers and sellers.3
Types of Repurchase Agreements
There are three main types of repurchase agreements.

 The most common type is a third-party repo (also known as a tri-party repo). In this
arrangement, a clearing agent or bank conducts the transactions between the buyer and
seller and protects the interests of each. It holds the securities and ensures that the seller
receives cash at the onset of the agreement and that the buyer transfers funds for the
benefit of the seller and delivers the securities at maturation. The primary clearing banks
for tri-party repo in the United States are JPMorgan Chase and Bank of New York
Mellon. In addition to taking custody of the securities involved in the transaction, these
clearing agents also value the securities and ensure that a specified margin is
applied.4 They settle the transaction on their books and assist dealers in optimizing
collateral. What clearing banks do not do, however, is act as matchmakers; these agents
do not find dealers for cash investors or vice versa, and they do not act as a broker.
Typically, clearing banks settle repos early in the day, although a delay in settlement
usually means that billions of dollars of intraday credit are extended to dealers each day.
These agreements constitute between 80%–90% of the repurchase agreement market,
which held approximately $4.2 trillion as of Jun. 9, 2022.5 6
 In a specialized delivery repo, the transaction requires a bond guarantee at the beginning
of the agreement and upon maturity. This type of agreement is not very common.
 In a held-in-custody repo, the seller receives cash for the sale of the security, but holds it
in a custodial account for the buyer. This type of agreement is even less common because
there is a risk the seller may become insolvent and the borrower may not have access to
the collateral.

Near and Far Legs

Like many other corners of the financial world, repurchase agreements involve terminology that
is not commonly found elsewhere. One of the most common terms in the repo space is the “leg.”
There are different types of legs: for instance, the portion of the repurchase agreement
transaction in which the security is initially sold is sometimes referred to as the “start leg,” while
the repurchase which follows is the “close leg.”7 These terms are also sometimes exchanged for
“near leg” and “far leg,” respectively. In the near leg of a repo transaction, the security is sold. In
the far leg, it is repurchased.8

The Significance of the Repo Rate

When government central banks repurchase securities from private banks, they do so at a
discounted rate, known as the repo rate. Like prime rates, repo rates are set by central banks. The
repo rate system allows governments to control the money supply within economies by
increasing or decreasing available funds. A decrease in repo rates encourages banks to sell
securities back to the government in return for cash. This increases the money supply available to
the general economy. Conversely, by increasing repo rates, central banks can effectively
decrease the money supply by discouraging banks from reselling these securities.9
In order to determine the true costs and benefits of a repurchase agreement, a buyer or seller
interested in participating in the transaction must consider three different calculations:

           1) Cash paid in the initial security sale

           2) Cash to be paid in the repurchase of the security

           3) Implied interest rate

The cash paid in the initial security sale and the cash paid in the repurchase will be dependent
upon the value and type of security involved in the repo. In the case of a bond, for instance, both
of these values will need to take into consideration the clean price and the value of the accrued
interest for the bond.

A crucial calculation in any repo agreement is the implied rate of interest. If the interest rate is
not favorable, a repo agreement may not be the most efficient way of gaining access to short-
term cash. A formula which can be used to calculate the real rate of interest is below:

Interest rate = [(future value/present value) – 1] x year/number of days between consecutive legs

Once the real interest rate has been calculated, a comparison of the rate against those pertaining
to other types of funding will reveal whether or not the repurchase agreement is a good deal.
Generally, as a secured form of lending, repurchase agreements offer better terms than money
market cash lending agreements. From the perspective of a reverse repo participant, the
agreement can generate extra income on excess cash reserves as well.9

Risks of Repo
Repurchase agreements are generally seen as credit-risk mitigated instruments. The largest risk
in a repo is that the seller may fail to hold up its end of the agreement by not repurchasing the
securities which it sold at the maturity date. In these situations, the buyer of the security may
then liquidate the security in order to attempt to recover the cash that it paid out initially. Why
this constitutes an inherent risk, though, is that the value of the security may have declined since
the initial sale, and it thus may leave the buyer with no option but to either hold the security
which it never intended to maintain over the long term or to sell it for a loss. On the other hand,
there is a risk for the borrower in this transaction as well; if the value of the security rises above
the agreed-upon terms, the creditor may not sell the security back.

There are mechanisms built into the repurchase agreement space to help mitigate this risk. For
instance, many repos are over-collateralized. In many cases, if the collateral falls in value, a
margin call can take effect to ask the borrower to amend the securities offered. In situations in
which it appears likely that the value of the security may rise and the creditor may not sell it back
to the borrower, under-collateralization can be utilized to mitigate risk.10
Generally, credit risk for repurchase agreements is dependent upon many factors, including the
terms of the transaction, the liquidity of the security, the specifics of the counterparties involved,
and much more.

The Financial Crisis and the Repo Market

Following the 2008 financial crisis, investors focused on a particular type of repo known as repo
105. There was speculation that these repos had played a part in Lehman Brothers’ attempts at
hiding its declining financial health leading up to the crisis.11 In the years immediately
following the crisis, the repo market in the U.S. and abroad contracted significantly. However, in
more recent years it has recovered and continued to grow.

The crisis revealed problems with the repo market in general. Since that time, the Fed has
stepped in to analyze and mitigate systemic risk. The Fed identified at least three areas of
concern:12

           1) The tri-party repo market’s reliance on the intraday credit which the clearing banks
provide

           2) A lack of effective plans to help liquidate the collateral when a dealer defaults

           3) A shortage of viable risk management practices

Starting in late 2008, the Fed and other regulators established new rules to address these and
other concerns. Among the effects of these regulations was an increased pressure on banks to
maintain their safest assets, such as Treasuries.12 They are incentivized to not lend them out
through repo agreements. Per Bloomberg, the impact of the regulations has been significant: up
through late 2008, the estimated value of global securities loaned in this fashion stood close to $4
trillion. Since that time, though, the figure has hovered closer to $2 trillion. Further, the Fed has
increasingly entered into repurchase (or reverse repurchase) agreements as a means of offsetting
temporary swings in bank reserves.1314

Nonetheless, in spite of regulatory changes over the last decade, there remain systemic risks to
the repo space. The Fed continues to worry about a default by a major repo dealer that might
inspire a fire sale among money funds which could then negatively impact the broader market.
The future of the repo space may involve continued regulations to limit the actions of these
transactors, or it may even eventually involve a shift toward a central clearinghouse system. For
the time being, though, repurchase agreements remain an important means of facilitating short-
term borrowing.15

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Table of Contents

 What Is the Overnight Rate?

 How the Overnight Rate Works
 Effects of the Overnight Rate
 Overnight Rate FAQs

 MONETARY POLICY  
 INTEREST RATES

Overnight Rate
By 
JAMES CHEN
 

Updated June 10, 2022

Reviewed by 
ERIC ESTEVEZ
Fact checked by 
PETE RATHBURN

What Is the Overnight Rate?

The overnight rate is the interest rate at which a depository institution (generally banks) lends or
borrows funds from another depository institution in the overnight market. In many countries,
the overnight rate is the interest rate the central bank sets to target monetary policy. In most
circumstances, the overnight rate is the lowest available interest rate, and as such, it is only
available to the most creditworthy institutions.

KEY TAKEAWAYS

 Overnight rates are the rates at which banks lend funds to each other at the end of the day
in the overnight market.
 The goal of these lending activities is to ensure the maintenance of federally-mandated
reserve requirements.
 When a bank cannot meet its reserve requirement, it will borrow from a bank that has a
surplus reserve.
 Overnight rates are predictors of short-term interest rate movement in the broader
economy and can have a domino effect on various economic indicators such as
employment and inflation.
  The higher the overnight rate is, the more expensive it is for consumers to borrow money,
as the increased cost to banks is passed onto consumers.

Overnight Rate

How the Overnight Rate Works

The amount of money a bank has fluctuates daily based on its lending activities and its
customers' withdrawal and deposit activity. A bank may experience a shortage or surplus of cash
at the end of the business day.

Those banks that experience a surplus often lend money overnight to banks that experience a
shortage of funds so as to maintain their reserve requirements. The requirements ensure that the
banking system remains stable and liquid.

The overnight rate provides an efficient method for banks to access short-term financing from
central bank depositories. As the overnight rate is influenced by the central bank of a nation, it
can be used as a good predictor for the movement of short-term interest rates for consumers in
the broader economy. The higher the overnight rate, the more expensive it is to borrow money.

 
As of May 2022, the Federal Funds rate sits at a rate of 0.77%; an increase from the previous
month's rate of 0.33%.1

In the United States, the overnight rate is referred to as the federal funds rate, while in Canada, it
is known as the policy interest rate. The rate increases when liquidity decreases (when loans are
more difficult to come by) and falls when liquidity increases (when loans are more readily
available). As a result, the overnight rate is a good indicator of the health of a country's overall
economy and banking system.

Effects of the Overnight Rate

The overnight rate indirectly affects mortgage rates in that as the overnight rate increases, it is
more expensive for banks to settle their accounts, so to compensate they will raise longer-term
rates.

The Federal Reserve influences the overnight rate in the United States through its open-market
operations. The overnight rate, in turn, affects employment, economic growth, and inflation. This
rate has been as high as 20% in the early 1980s and as low as 0% after the Great Recession of
2007-08.1

Is the Bank Rate the Same as the Overnight Rate?

No, the bank rate and the overnight rate are not the same. The bank rate is also known as the
discount rate, which is the rate that banks can borrow from the central bank. The overnight rate,
also known as the federal funds rate, is the rate at which banks can borrow from one another.

Why Do Banks Borrow Overnight?

Banks are required by the central bank to keep a minimum amount of reserves to ensure liquidity
in the banking sector. The reserves of banks fluctuate depending on customer withdrawals and
deposits. When banks have a shortfall and cannot meet their reserve requirement, they will
borrow from banks with a surplus to do so.

How Does the Overnight Rate Affect the Prime Rate?

When the overnight rate is increased by the central bank, it becomes more expensive for banks to
borrow money from one another, increasing their total cost. To make up for this increase in
costs, banks increase their prime rates, which makes borrowing money for customers more
expensive. In essence, banks pass the increased cost onto the consumer.

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might think. With OKX, a leading digital asset financial service provider, you can access world-
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Table of Contents

 What Is a Bank Rate?

 How Bank Rates Work
 Types
 Bank Rate vs. Overnight Rate
 Example
 Bank Rate FAQs
 The Bottom Line

 MONETARY POLICY  
 INTEREST RATES
Bank Rate
By 
WILL KENTON
 

Updated August 30, 2021

Reviewed by 
CHARLES POTTERS

What Is a Bank Rate?

A bank rate is the interest rate at which a nation's central bank lends money to domestic banks,
often in the form of very short-term loans. Managing the bank rate is a method by which central
banks affect economic activity. Lower bank rates can help to expand the economy by lowering
the cost of funds for borrowers, and higher bank rates help to reign in the economy when
inflation is higher than desired.

KEY TAKEAWAYS

 The bank rate is the interest rated charged by a nation's central bank for borrowed funds.
 The Board of Governors of the U.S. Federal Reserve System set the bank rate.
 The Federal Reserve may increase or decrease the discount rate to slow down or
stimulate the economy, respectively.
 There are three types of credit issued by the Federal Reserve to banks: primary credit,
secondary credit, and seasonal credit.
 Contrary to the bank rate, the overnight rate is the interest rate charged by banks loaning
funds to each other.

How Bank Rates Work

The bank rate in the United States is often referred to as the discount rate. In the United States,
the Board of Governors of the Federal Reserve System sets the discount rate as well as the
reserve requirements for banks.

The Federal Open Market Committee (FOMC) buys or sells Treasury securities to regulate the
money supply. Together, the discount rate, the value of Treasury bonds, and reserve
requirements have a huge impact on the economy. The management of the money supply in this
way is referred to as monetary policy
Types of Bank Rates
Banks borrow money from the Federal Reserve to meet reserve requirements. The Fed offers
three types of credit to borrowing banks: primary, secondary, and seasonal. Banks must present
specific documentation according to the type of credit extended and must prove they have
sufficient collateral to secure the loan.1

Primary Credit

Primary credit is issued to commercial banks with strong financial positions. There are no
restrictions on what the loan can be used for, and the only requirement for borrowing funds is to
confirm the amount needed and loan repayment terms.

Secondary Credit

Secondary credit is issued to commercial banks that do not qualify for primary credit. Because
these institutions are not as sound, the rate is higher than the primary credit rate. The Fed
imposes restrictions on use and requires more documentation before issuing credit. For instance,
the reason for borrowing the funds and a summary of the bank's financial position are required,
and loans are issued for a short-term, often overnight.

Seasonal Credit

As the name suggests, seasonal credit is issued to banks that experience seasonal shifts in
liquidity and reserves. These banks must establish a seasonal qualification with their respective
Reserve Bank and be able to show that these swings are recurring. Unlike primary and secondary
credit rates, seasonal rates are based on market rates.

Bank Rate vs. Overnight Rate

The discount rate, or bank rate, is sometimes confused with the overnight rate. While the bank
rate refers to the rate the central bank charges banks to borrow funds, the overnight rate—also
referred to as the federal funds rate—refers to the rate banks charge each other when they borrow
funds among themselves. Banks borrow money from each other to cover deficiencies in their
reserves.

 
The bank rate is important since commercial banks use it as a basis for what they will eventually
charge their customers for loans.

Banks are required to have a certain percentage of their deposits on hand as reserves. If they
don't have enough cash at the end of the day to satisfy their reserve requirements, they borrow it
from another bank at an overnight rate. If the discount rate falls below the overnight rate, banks
typically turn to the central bank, rather than each other, to borrow funds. As a result, the
discount rate has the potential to push the overnight rate up or down.
As the bank rate has such a strong effect on the overnight rate, it also affects consumer lending
rates. Banks charge their best, most creditworthy customers a rate that is very close to the
overnight rate, and they charge their other customers a rate that is a bit higher.

For example, if the bank rate is 0.75%, banks are likely to charge their customers relatively low-
interest rates. In contrast, if the discount rate is 12% or a similarly high rate, banks are going to
charge borrowers comparatively higher interest rates.

Example of Bank Rates

A bank rate is the interest rate a nation's central bank charges other domestic banks to borrow
funds. Nations change their bank rates to expand or constrict a nation's money supply in response
to economic changes.

In the United States, the discount rate has remained unchanged at 0.25% since March 15,
2020.2 In response to the global financial crisis, the Fed lowered the rate by 100 basis points.
The main goal was to stabilize prices, prevent rises in unemployment, and encourage the use of
credit among households and businesses.

Among all nations, Switzerland reports the lowest bank rate of -0.750%, and Turkey—known for
having high inflation— has the highest at 19%.3

14%
The highest United States discount rate ever declared (June 1981).4

What Happens When the Central Bank Increases the

Discount Rate?
To counter inflation, the Central bank may increase the discount rate. When increased, the cost to
borrow funds increases. In turn, disposable incomes decrease, it becomes difficult to borrow
money to purchase homes and cars, and consumer spending decreases.

If the Fed Lowers the Federal Funds Rate, What Happens

to Savings Accounts?
The federal funds rate is the interest rate banks charge each other to borrow funds, whereas the
discount or bank rate is the rate the Federal Reserve charges commercial banks to borrow funds.
A lowered discount rate correlates to lower rates paid on savings accounts. For established
accounts with fixed rates, the lowered discount rate has no effect.

What Interest Rate Does a Commercial Bank Pay When It

Borrows From the Fed?
The interest rate a commercial bank pays when it borrows from the Fed depends on the type of
credit extended to the bank. If issued primary credit, the interest rate is the discount rate. Banks
that do not qualify for primary credit may be offered secondary credit, which has a higher
interest rate than the discount rate. Seasonal credit rates fluctuate with the market and are tied to
it.

The Bottom Line

A bank rate is the interest rate a nation's central bank charges to its domestic banks to borrow
money. The rates central banks charge are set to stabilize the economy. In the United States, the
Federal Reserve System's Board of Governors set the bank rate, also known as the discount rate.

Banks request loans from the central bank to meet reserve requirements and maintain liquidity.
The Federal Reserve issues three types of credit according to the financial position of the bank
and their needs. In contrast to the bank rate, the overnight rate is the interest rate fellow banks
charge each other to borrow money.

In response to the global crisis, many central banks have changed their bank rates to stimulate
and stabilize the economy. In March 2021, the United States responded by lowering its discount
rate to 0.25%.

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Related Terms
Federal Funds Rate: What It Is, How It's Determined, and Why It's Important
The federal funds rate is the target interest rate set by the Fed at which commercial banks
borrow & lend their extra reserves to one other overnight.
 more
Monetary Policy Meaning, Types, and Tools
Monetary policy is a set of actions available to a nation's central bank to achieve sustainable
economic growth by adjusting the money supply.
 more
Overnight Rate
The overnight rate is the interest rate at which a depository institution can lend or borrow funds
that are required to meet overnight balances.
 more
Federal Reserve System (FRS) Definition
The Federal Reserve System is the central bank of the United States and provides the nation
with a safe, flexible, and stable financial system.
 more
Federal Discount Rate Definition
The federal discount rate is the reference interest rate set by the Federal Reserve for lending to
banks and other institutions.