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Bank Rate Definition
A bank rate refers to the interest rate that the central bank charges commercial and domestic banks for lending funds to them. It is also called the discount rate, this rate is charged on all loans issued to commercial banks. One major way the central bank influences the economy is through the bank rate. This interest rate is often low and in turn gives room for the expansion of the economy.
A Little More on What is a Bank Rate
In the United States, the bank rate is called the federal funds rate or the discount rate. This interest rate is set by the Board of Governors of the Federal Reserve System. It serves as a benchmark for interest collection on loans that the central bank advances to commercial banks. This rate is also a major requirement for banks as it helps keep the economy in check.
Aside from the federal funds rate, the treasury security that the Federal Open Market Committee (FOMC) trades also have a significant impact on the economy. These are parts of the monetary policy adopted in the United States.
Discount Rate Versus Overnight Rate
The discount rate or bank rate is not the same as the overnight rate. While the bank rate refers to the rate the central bank charges commercial banks for lending them funds, the overnight rate is charged by banks when they borrow other banks funds.
To be clear, bank rate is charged by the Central Bank to banks while the overnight rate is charged by a bank to another bank. There are cases where banks borrow funds from each other and the bank lending the money charges a percentage as interest called the overnight rate. Usually, if the bank rate is lower than the overnight rate, banks go to the central bank for funding.
How the Bank Rate Affects Consumer Interest Rates
Bank rates or discount rates have significant effects in the consumer interest rates. Usually, most banks charge their customers using an interest rate close to the overnight rate, however, this is only applicable for customers with good credit rating. Customers that do not have high creditworthiness are exposed to higher invest rates when they go to banks for funding.
Bank rate directly affects consumer interest rates, the higher the bank rate, the higher the consumer interest rates. When central banks also charge low bank rates, consumer interest rates are lower.
Reference for “Bank Rate”
Academics research on “Bank Rate”
Bank rate policy under the interwar gold standard: a dynamic probit model, Eichengreen, B., Watson, M. W., & Grossman, R. S. (1985). Bank rate policy under the interwar gold standard: a dynamic probit model. The Economic Journal, 95(379), 725-745.
Commercial bank net interest margins, default risk, interest-rate risk, and off-balance sheet banking, Angbazo, L. (1997). Commercial bank net interest margins, default risk, interest-rate risk, and off-balance sheet banking. Journal of Banking & Finance, 21(1), 55-87. This paper tests the hypothesis that banks with more risky loans and higher interest-rate risk exposure would select loan and deposit rates to achieve higher net interest margins. Call Report data for different size classes of banks for 1989–1993 show that the net interest margins of commercial banks reflect both default and interest-rate risk premia. The net interest margins of money-center banks are affected by default risk, but not by interest rate risk, which is consistent with their greater concentration in short-term assets and off-balance sheet (OBS) hedging instruments. By contrast, (super-) regional banking firms are sensitive to interest-rate risk but not to default risk. The data show that OBS activities promote a more diversified, margins-generating asset base than deposit- or equity-financing, and that cross-sectional differences in interest-rate risk and liquidity risk are related to differences in OBS exposure.
The rate of interest, the bank rate, and the stabilization of prices, Cassel, G. (1928). The rate of interest, the bank rate, and the stabilization of prices. The Quarterly Journal of Economics, 42(4), 511-529. Relative prices and the absolute height of prices. — Interest as a price, 512. — The equilibrium rate of interest is a price; how it is determined, 513. — The absolute height of prices, 515. — The bank rate, 516. — Stability of prices is possible only when the bank rate is the same as the equilibrium rate, 517. — No other device is adequate, 519. — The gold standard does not bring stability of prices, 520. — A manipulated bank rate may mitigate the instability, but with disturbing effects, 521. — Some explanations: special conditions of a progressive society; various kinds of interest rates; how the rate of interest affects prices, 523. — Dynamic as contrasted to static conditions; cyclical movements; futility of mathematical wave theories, 526.
Retail bank interest rate pass-through: new evidence at the euro area level, De Bondt, G. (2002). Retail bank interest rate pass-through: new evidence at the euro area level. This paper presents an error-correction model of the interest rate pass-through process based on a marginal cost pricing framework including switching and asymmetric information costs. Estimation results for the euro area suggest that the proportion of the pass-through of changes in market interest rates to bank deposit and lending rates within one month is at its highest around 50%. The interest rate pass-through is higher in the long term and notably for bank lending rates close to 100%. Moreover, a cointegration relation exists between retail bank and comparable market interest rates. Robustness checks, consisting of impulse responses based on VAR models and results for a sub-sample starting in January 1999, show qualitatively similar findings. However, the sub-sample results are supportive of a quicker pass-through process since the introduction of the euro.
The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank, Estrella, A., & Mishkin, F. S. (1997). The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank. European economic review, 41(7), 1375-1401. This paper examines the relationship of the term structure of interest rates to monetary policy instruments and to subsequent real activity and inflation in both Europe and the United States. The results show that monetary policy is an important determinant of the term structure spread, but is unlikely to be the only determinant. In addition, there is significant predictive power for both real activity and inflation. The yield curve is thus a simple and accurate measure that should be viewed as one piece of useful information which, along with other information, can be used to help guide European monetary policy.