In the US there are two institutions that have authority over interest rates: the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve. The board makes its decisions on interest rates after submissions by one or more of the regional Federal Reserve banks. The FOMC, on the other hand, is involved in open market transactions that include the desired federal funds interest rate and the appropriate level for central bank money.
The twelve regional Federal Reserve banks are situated at Boston, Philadelphia, Cleveland, New York, Richmond, Atlanta, St. Louis, Minneapolis, Chicago, Kansas City, Dallas and San Francisco.
The Federal Reserve establishes a base rate, which is the rate at which it grants loans to individual banks. The base rate changes because of a variety of reasons, some of which include:
• If inflation is higher than the Federal Reserve’s targeted figure, the base rate is usually increased in an attempt to curtail spending. The underlying philosophy here is that inflation is demand-based.
• If the country’s economic growth were sluggish, the Federal Reserve would usually cut the base rate to try to stimulate the economy. During the current economic recession, the Reserve has used this approach several times in an attempt to counteract the economic decline.
This base rate or discount rate, of course, directly influences the cost of money for the individual banks, which is why it is used as a basis for their own lending activities to individual customers.
If the Federal Reserve should increase its interest rate, this will increase the cost of money for the individual banks and they would accordingly have to increase the interest rate they charge to individual customers.
Conversely, if the Federal Reserve decreases interest rates, it decreases the cost of borrowing for individual banks. Theoretically, at least, they should therefore decrease the rates they charge to individual customers.
The interest rates banks charge to individual customers, although directly influenced by the base rate, are based on a variety of other factors. One of the main criteria is the creditworthiness of the individual borrower. A high-risk borrower will pay higher interest rates for US bank mortgages than a low-risk borrower will, as a rule. That is why a good credit record is of the utmost importance if you want to keep your lending cost in check.
Short-term loans usually carry a higher interest rate than long term loans, i.e. bank overdrafts are more expensive than housing loans.
Membership of the Federal Reserve
More than 33 percent of US commercial banks belong to the Federal Reserve System. It is obligatory for national banks to be members. Chartered state banks may become members if they meet certain requirements.
The largest, in terms of deposits of the many member banks, are listed below:
Bank of America, Wells Fargo Bank, JP Morgan Chase Bank, Citibank, PNC Bank, US Bank, TD Bank, Sun Trust Bank, Branch Banking and Trust Company, Regions Bank, HSBC Bank (USA), Capital One.
