It's Time For Banks To Lower The Prime

Why is the bank prime rate still at 6% when short-term T-bills are approaching 3% and 30-year Treasury bonds are down to 6.17%? It isn't because the banks are worried about profits--their earnings are soaring and profits are at record levels. It isn't because of credit quality. Most banks have more than enough capital to cover past mistakes in real estate, energy, and Third World loans. It isn't because of the banks' cost of money, either. The gap between the federal funds rate and the prime has actually widened over the past two years.

The reason the prime rate remains so high is that banks do not appear to be seriously interested in making loans. While interest rates have been falling everywhere, the prime hasn't budged in more than a year. Bankers prefer to make money the easy way--on the spread between the short-term rates they pay for cash and the higher rates they receive from investing in Treasury and government-guaranteed paper. Nice work if you can get it. No risk. All gain.

This wouldn't be half so callous had not the country as a whole sacrificed to make the banks so healthy. The effect of the Federal Reserve's policy to lower interest rates, ignoring the historic spread between short-term rates and the prime, has been to bail out the banks. But banks have yet to return the favor by cutting their key lending rates.

So far, Congress and the Fed have been content to let banks avoid the risk that comes with the real business of banking--lending money to real customers. To do that, banks would have to get competitive and lower the prime to 5% to 51 2%, where it probably should be, given the cost of money.

Banks say lowering the prime won't do any good because there aren't borrowers because of the weak economy. But if they cut the prime and worked at finding promising small companies in need of cash to grow, bankers might discover a lot of business. Managing risk is supposed to be what banks are all about. It's time they got back in the game.

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