This is because banks have to borrow money, as strange as it sounds; benchmark lending determines how profitable a bank is and how much it charges its customers to borrow money. A bank is required by law to have liquid or cash reserves. If the bank loans the cash out, it loses that reserve until it’s paid back. A bank will employ benchmark lending to borrow money at 1% for example, and then offer a mortgage to a customer at 5%. The difference or 4% is the bank’s profit on the transaction. For individuals that hold credit cards with variable interest rates, benchmark lending impacts the amount of their monthly payments as interest rises or falls based on the benchmark.
Benchmark lending is vital in an economy that requires a constant influx of cash to offer growth. Benchmark lending allows for money to move from one lender to another or from a lender to a corporation for the creation of jobs through expansion of goods and services. For this reason, the prime rate in the United States was at nearly zero percent to encourage corporations and small businesses alike to invest money into growth.
It is important to remember that in benchmark lending, the benchmark rate and the prime rate may not be the same. The prime rate is set by a governmental agency, while a benchmark is set by a corporation or individual. Benchmark lending institutions may tie their rate to the prime rate for purposes of uniformity and marketability, but they are under no obligation to do so.