How Bank Rates are Reflected by the Federal Rate

The Federal rate is the percent of interest that the central bank (Federal Reserve) charges other banks for overnight loans.  The Fed Rate is, therefore a short term interest rate, and not one that consumers can directly take advantage of.  The Fed Rate is commonly referred to as the discount rate, or even the prime rate.

Though the consumer cannot directly take advantage of the Fed Rate, the system has a trickledown effect because it impacts interest rates that banks will charge their commercial and residential customers.

• Understand how market conditions impact interest rates.  When the economy is in recession, the Federal Reserve chairman has the ability to lower its rate.  The Federal Reserve meets quarterly to evaluate the need to raise or lower this key interest rate, but they can meet for an emergency session if market conditions deem it necessary.  The logic behind this move is that if banks can get “cheap money” they will take that money and lend it to customers.  This will in turn encourage consumer spending, and potentially re-financing, and investing.


• Understand that interest rates will vary depending on your specific financial institution.  Though the fed rate may be low – say 3 percent, your particular financial institution may not be able to borrow at 3 percent.  If your bank cannot borrow at this rate, you will not be able to borrow from your bank at this rate.  The rate at which your financial institution can borrow depends on the credit rating of that institution.  If you are shopping around for a bank, ask about interest rates, and other financial products available.


• Understand that interest bearing accounts are impacted by the Fed Rate.  If your bank can borrow at 3 percent, and lend at 4 percent, chances are low that you will realize more than perhaps 2 percent maximum on an interest bearing CD or savings account.  While low interest rates are fabulous for borrowing money, they are undesirable when it comes to savings.  Bank customers who have some liquid cash are better to invest in medium term bonds or high dividend blue chip stocks.  Be certain to consider financial decisions such as where to place your money carefully before committing.