The prime rate is the rate of interest, reported as a percentage, charged by commercial banks on short-term loans to the nation's largest, most credit-worthy corporations. Relatively few U.S. corporations may borrow at this rate. Occasionally banks lend slightly below the prime rate to very low risk corporations. A firm will frequently be quoted a rate slightly higher than prime. As an example, the quote might be prime plus one-half, i.e., if the prime was six percent, the firm might be quoted 6.5 percent. The prime is an important indicator of short-term credit conditions.
The prime rate also serves as a basis for interest rate quotes to individual customers. Mortgage rates rise and fall as the prime rate moves up and down. Individuals might receive a home equity loan or line of credit at a rate of "prime plus three percent."
The prime rate depends on the cost of funds loaned to the commercial bank by the regional Federal Reserve Bank. This cost of funds is the discount rate. When the discount rate lowers, the savings are passed on within a few days to commercial banks and reflected in their prime and all other consumer loan rates. An increase in the discount rate, in contrast, results in an increase in the prime and other consumer loan rates.
Between 1934 and 1950 the prime rate remained in the 1.50 to 2.25 percent range. The 1950s and 1960s witnessed four to eight percent rates. In September of 1973 the prime climbed to 11 percent on its way to an all time high of 21.5 percent in December of 1980. Rates in the 1990s ranged from six to 10 percent.
See also: Federal Reserve System, Interest