Fed Reserve increases interest rate, what interest rate is it? Is it the rate we receive from bank?

Question

I just read an article, it said the Fed Funds Rate is the borrowing cost of banks in overnight lending market.. not the prime rate

Answer 1

The answers above are close.

A) It is one of two rates, the discount rate or the Federal funds rate.

1A) The discount rate is the rate the Federal Reserve charges member banks for overnight loans, usually to cover reserve shortfalls but not always for that purpose.

2A) The Federal funds rate is the rate banks charge other banks for the loan of their unused cash reserves. It impacts this rate by buying or selling US Government securities to banks thereby drying up free funds or adding free funds through these sale transactions.

B) No, it is not the rate you receive from the bank. The bank will charge you a rate based upon your assessed riskiness, the risk of the type of the loan in general, broader portfolio management needs, and the rates for similar type loans charged by other competitors. Your loan rate is based upon supply and demand in your market. The Federal funds rate is the cost of the money to the bank so your rate should always be above the bank's cost for the money to lend to you.

Answer 2

OPM is right -- give him the points -- but here are some more details.

The Fed Funds Rate is not the rate that the Federal Reserve charges banks to borrow money to deposit with the Federal Reserve -- it is the rate that one bank charges another.

Every two weeks, banks have to measure their deposits and put some of it on reserve with the Federal Reserve. If a bank's deposits go up, it needs to put more money in its account with the Fed. It can either raise the cash, or it can borrow it from another bank that has excess funds. Similarly, if a bank's deposits went down, it can get some money back from the Fed, or you can lend its funds to a bank that needs to put more in.

It doesn't seem like the Fed can regulate this rate when they are not a party to the trade. Technically, this is true -- the banks set the rate, not the Fed.

But there are alternative ways for a bank to raise cash. They can lend out securities in the Repo market to get cash to deposit with the Fed. If it is cheaper to do this than to borrow in the Fed Funds market -- banks will go to the Repo Market.

There are two things that the Fed has lots of -- Securities and Cash. If they want to change the Fed Funds rate, they lend or borrow money ni the Repo market to change the rates there. Depending on what happens, banks will decide to borrow in the repo market (making less demand for fed funds, and bringing down rates) or borrowing in the Fed Funds market (creating more demand bringing up rates).

The interesting thing that you might notice here is that the market doesn't have to go along with what the Fed wants. This sometimes happens -- the market tells the Fed "No -- we aren't going there -- this is the rate."

Answer 3

When you see that the Fed has raised the "interest rates"; it is referring to Fed funds rates... the rate the Fed charges to its banks for borrowing money...

What that translates to for us is the Prime rate... defined as the rate that a bank charges its best customers.

When this rate is raised or lowered, it affects so much more than the Prime rate, however. It ususally affects the stock market and the bond markets among other things.

Answer 4

It's the rate the Federal Reserve charges to banks for overnight loans.

Banks are required by law to keep a certain amount of cash or cash equivalents in reserve. If they are short that amount at the end of the day, they have to borrow it from the Federal Reserve overnight.

Answer 5

They raise the Prime Rate. When you go out to get a loan it is prime + a risk factor.

Answer 6

it is for sure an attempt to stimulate the economic equipment and inspire better spending and funding. even if, as you write, their effectiveness is unclear; the expenses charged to debtors with suggestions from banks stay intense (round 7%). even if, were expenses of interest larger, the concern may be altogether better troublesome.