how interest rates set

8/17/2019 How Interest Rates Set

1/9

Hailey College of Banking

and Finance

FI(How Interest Rates Set)

(BBA 7

th

Semester)Instructor A!dul "adeerdr#a$khan%li&e#com'*+7,7*


2/9

-ach .onth/ the Bank of -ngland0s .onetary 1olicy

Committee meets to set the 23cial 4ealing Rate# 5his is

the rate at which the Bank of -ngland is 6re6ared to lendto commercial !anks#

In the S/ the Federal Reser&e Board sets the 4iscountRate at which commercial !anks can !orrow money from

Federal Reser&e Board !anks#

A loan from !oth the Bank of -ngland and the Federal

Reser&e Board to a commercial !ank is regarded as safethe interest 6ayments will !e made and the ca6ital will !ere6aid# Hence/ there is no additional 6remium in theseinterest rates to co&er the cost of default#

5he 23cial 4ealing Rate (in -ngland) and the 4iscount

Rate (in the S) re6resent a 8minimum interest rate#

How Interest Rates Set9


3/9

A .onetary 1olicy Committee (.1C) consisting of :o&ernor

(or a 4e6uty :o&ernor nominated !y the go&ernor in hisa!sence)/ three senior -;ecuti&es of the SB1/ three mem!ers

of the Board and three e;ternal mem!ers who shall !eeconomists and a66ointed !y the go&ernment onrecommendations of the Board was esta!lished to formulate/su66ort and recommend the .onetary 1olicy Statement andother monetary 6olicy measures#

5he main o!>www#!recorder#com>editorials>'>?,*+'@?theamendedstate!ankof6akistanlaw

>

.onetary 1olicy Committee of

SB1

http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/http://www.brecorder.com/editorials/0:/1248051:the-amended-state-bank-of-pakistan-law/


4/9

Business and 6u!lic !orrow money from the commercial !anks

and other institutions# 5he interest rate $uoted !y thecommercial !anks are often called 8!ase rates and loans fromcommercial !anks to small !usiness and the 6u!lic are set inrelation to !ase rate# But now there is a risk of default on the6ayments#

5he interest is low with high creditworthy institution and highfor a low creditworthy institutions# So the commercial !anks willcharge a num!er of 6ercentage 6oints a!o&e !ase rate# For a

creditworthy institution/ this might !e , 6ercentage 6ointsa!o&e !ase rate for a loan to which a large amount of risk isattached/ this could !e +?' 6ercentage 6oints a!o&e !ase rate#

So if the !ase rate was @D/ a creditworthy com6any>indi&idualmight 6ay 7D or +D on their loan# A !orrower with a 6oor credithistory might 6ay ?D to ?@D or more#


5/9

Sometime/ the 6ercentage is e;6ressed in !asis 6oints#

2ne !asis 6oint is ? > ?''th of ?D# So '#@D a!o&e !ase

rate might !e descri!ed as 8!ase rate 6lus @' !asis6oints

Banks will not e;tend the same interest rate toin&estors and !orrowers# 5he rate they will 6ay to thosede6ositing funds in the !ank is called !id rate# 5he ratethey will charge for lending money is the oEer rate# 5he!id rate will !e lower than the oEer rate#


6/9

arge international !anks are hea&ily in&ol&ed in lending

and !orrowing money in all currencies from other large

international !anks# 5he rate used in these transactions is!ased on the IB2R rate (ondon Inter!ank 2Eered Rate)#

IB2R is the rate at which !anks can !orrow money fromother !anks in the ondon inter!ank market# Since there is

a small risk of default in these transactions/ IB2R rateswill !e a!o&e the 23cial 4ealing Rate# But !anks are

usually more creditworthy than small !usinesses and6ri&ate citiGens so IB2R will !e !elow those rates oEered!y commercial !anks#

5he IB2R rate is set !y the British Banker0s Association

(BBA) at ??'' am on each !usiness day# IB2R is the mostwidely used reference rate for short term interest rate#

5he i!or rate


7/9

It is used as the !asis for the settlement of interest rate

contracts on many of the world0s ma


8/9

5o set the IB2R/ the British Banker0s Association/

acting with the ad&ice of senior market 6ractitioners/refers to a 6anel of at least eight contri!utor !anks# 5hese !anks are chosen to reKect the com6osition ofthe market# In selecting its 6anel/ the BBA mightconsider a !ank0s re6utation/ e;6ertise/ siGe of marketacti&ity and in 6articular the in&ol&ement of the !ank inthe currency whose IB2R rate is to !e determined#

BBA IB2R rate are set daily for nine internationalcurrencies 6ound sterling/ S dollar/ a6anese yen/Swiss franc/ Canadian dollar/ Australian dollar/ euro/4anish krone and the ew Lealand dollar#


9/9

5he IB2R rate is $uoted in the =nancial 6ress as

annual rate#

So if the onemonth IB2R rate is *#7,'''D then on anin&estment of M ?' '''/ amount after onemonth

N ?'''' O?P '#'*7,Q?>?, N M ?''J#

If the threemonth IB2R rate is *#J?+7@D then amount

after three months N ?'''' O?P>?, Q '#'*J?+7@ N M?' ?,,#J7

4ay Count Con&entions 6age ?*J to ?@,#

how interest rates set

Documents