Bank Interest: You Just Can't Win

When the Federal Reserve jacked up short-term rates by a half-point on Aug. 16, the banks raised the prime rate faster than you can holler "cost of capital." Within hours, in fact. But back when the Fed was easing rates, between 1989 and 1992, banks took their sweet time cutting the prime lending rate in response.

The lockstep increases have been going on since the Fed began tightening early this year. When it hiked the federal funds rate, the prime--which banks charge their best corporate customers--ascended within days, if not sooner. All through 1990, though, the prime stayed at 10%, while the federal funds rate dipped more than a point, to 7.2% (chart).

What's the rationale? To the banks, the 1989-92 prime-rate inertia was justified because then they were drowning in massive bad loans made in the 1980s. Says consultant Bert Ely: "They needed that spread." This year, the spread is one reason banks are booking fat earnings.

Now that the banks have clearly recovered, they're trying to maintain healthy margins. But don't despair: Banks are still seeking to win over corporate and consumer borrowers. So where some credit-card customers once were billed prime plus seven points, it's now often only prime plus six points.

Before it's here, it's on the Bloomberg Terminal.