I am not going to take any credit for this, although it is a very good article on how the overnight lending rate influences the banks’ prime rate. For your convenience it is reprinted from the CBC web-site. (or click here to go directly to CBC for the entire article)
* The overnight rate is the interest percentage paid by banks and other institutions to lend money to each other, which they do on a daily basis.
* This rate is set eight times a year by the Bank of Canada as a means of influencing monetary policy.
* A bank’s prime lending rate is set at a given percentage above the overnight rate.
* All five of Canada’s biggest banks have set their prime lending rates at three per cent since September 2010, when the Bank of Canada raised its overnight rate by 0.25 per cent to one per cent.
* Historically, the large Canadian banks have adjusted their prime lending rates in tandem, tracking the Bank of Canada’s overnight rate.
The major banks don’t always adjust their prime lending rates in lockstep with the Bank of Canada’s overnight rate, however. For example, in December 2008, the Bank of Canada cut its overnight lending rate from 2.25 per cent to 1.5 per cent, a reduction of 0.75 per cent. Canadian banks cut their prime lending rates by just 0.5 per cent.
The price of lending money is ultimately up to the banks that lend it, explained David Madani, Canada economist at Capital Economics. “If they perceive perhaps there’s some increased risk in lending to households or businesses,” the banks will decide not to reduce their prime rate in order to mitigate that risk.