There are a number of different factors that may influence a bank’s decision to adjust its prime lending rate in addition to the Bank of Canada’s Bank Rate including:
- Conditions in the financial markets
- Availability of funds in the credit markets
- Cost of funds in the credit markets
The bottom line
Interest rate decisions by individual banks and other financial institutions are business decisions made in a competitive marketplace.
While the Bank of Canada rate does influence the pricing of short-term credit, it does not set the interest rates that consumers pay on their loans or receive on their deposits.
Banks obtain funding for loans from a wide variety of short- and long-term funding sources, including deposits, GICs and bonds, so the cost of this borrowing for banks does not necessarily mirror the Bank of Canada rate.
How does the Bank of Canada affect bank lending rates?
In a competitive marketplace, financial institutions continually assess market conditions to determine the interest rates they charge on loans, whether for short-term loans or long-term loans. An individual bank’s decisions on lending rates are impacted by its own cost of raising funds which in turn is affected by a variety of factors, including conditions in the financial markets, availability of funds, and other economic and market conditions.
There is a common misconception that the cost of credit provided by banks to their customers is driven by the Bank of Canada’s overnight rate. While the Bank of Canada’s overnight rate does influence the pricing of very short-term credit, this is less than 1% of funding that banks use for lending.
Banks obtain funding from a wide variety of short- and long-term funding sources, including deposits, GICs, securitized mortgages, bonds and subordinated debentures among others. The cost of this borrowing for banks does not necessarily mirror the Bank of Canada’s overnight rate.
Bank lending rates can decrease despite no change to their prime rates
Data from the Bank of Canada demonstrates that despite the fact that the overnight rate and the banks’ prime lending rates remained stable between September 2010 and January 2015, lending rates paid by borrowers decreased to historically low levels.
During this period, while banks’ prime lending rates were set at 3% and the Bank of Canada’s overnight rate remained at 1%, the effective interest rates for both business and household lending decreased by around 0.3%. Individuals and businesses were able to benefit from lower lending rates despite no change to the Bank of Canada’s overnight rate or the banks’ prime lending rates.
Following the Bank of Canada rate cuts in 2015, the banks reduced their prime lending rates which translated into lower borrowing costs for both businesses and consumers. In fact, according to a report from Mortgage Professionals Canada, the average mortgage interest rate fell to 3.07% in the fall of 2015 from 3.24% in the fall of 2014 – with the spread narrowing between fixed- and variable-rate mortgages. And of the mortgage holders who renewed their mortgage in the last 12 months, 83% saw a reduction in their rate.1
1 Annual State of the Residential Mortgage Market in Canada, Mortgage Professionals Canada, December 2015