Prime rate is the interest rate at which bank is suppose to lend money to their best customers. It is set as a reference to determine what are the best possible terms at which some one can get interest. In actual, interest rates could either be higher or lower than the prime.
Federal Open Market Committee (FOMC) mandate is to determine the prime interest rate & money supply.It was formed through the Banking Act of 1933 & were supposed to meet four times a year. However since 1981, they are meeting every five to eight weeks at least 8 times a year to fulfill the same mandate. FOMC is meeting again today and tomorrow to see if any changes are required before the next meeting in January 26-27th.
Interest rates are frozen at 3.25 since Dec 16th 2008. As a reference, it peaked at 21.5% on December 19th 1980. This is the longest unchanged interest rate in the history.
Here is a historical data on interest rates.
With such low interest rates, it is becoming more and more difficult for banks to offer saving accounts. Margins are shrinking for them and people are looking for alternatives to get higher returns. Lower interest rate is responsible for the higher valuations of companies & real estate.
Technically any deposits in saving accounts is the money lent by banks to lend it further. If they are unable to lend it faster than they are getting deposits, they have to pay interest from their own balance sheet. This is why banks are allowed to lend up-to 9X of the deposits they have. Just as an example for every $10, they can lend up-to $100. Bank with higher lend to deposit ratio will always have a healthy P/L statement.
Higher interest rate will hurt the banks with lower lend to deposit ratio.
There is a high probability that this meeting will end the longest interest rate freeze, it would be a good news for bank stake-holders. It would for sure lower down the demand for capital since it is more expensive to borrow, however will also correct the market valuations. Not correlated, but the oil price have rebounded above $35 for the first time since 2009.
Let’s wait till tomorrow to see if there are any changes announced.