4 Ways the Federal Reserve Impacts Corporate Borrowing
The Federal Reserve sets the Federal Funds Rate, which is the interest rate at which banks and credit unions can lend excess reserve balances to other banks and lenders overnight. Each bank is required to keep a certain amount of funds in reserves based on the size and risk of their loan portfolios. To the extent a bank has excess deposits compared to their reserves, they are then able to lend out money to other lenders at the federal funds rate.
There are 4 ways the Federal Reserve directly or indirectly impacts corporate borrowing.
#1: By adjusting the Federal Funds Rate, the Fed affects how expensive it is for lenders to borrower from one another.
This trickles down and affects the interest rate a lender offers a corporate borrower. Non-bank lenders are affected by this even more because they access the majority of their capital from large banks.
#2: As the Federal Funds Rate rises, the cost of borrowing for lenders also rises.
Lenders of course could limit their lending to the size of what their cash deposits would allow; however, they would fail to deliver returns to their shareholders. When their borrowing costs rise, they inevitably pass it along to the borrower in the form of higher rates.
#3: Federal Funds Rates tend to increase as the economy performance improves.
Loan demand increases as companies require more growth capital, expansion projects and acquisitions. With more loan demand in a strong economy, banks can afford to raise the cost of capital.
#4: The difference between short term rates and long-term rates tend to increase.
No idea what other point you were trying make here.
In environments of rapidly changing Federal Funds rates, whether it’s up or down, it is important to realize that banks react to rate changes at different speeds.
- In a rate decrease environment banks trying to grow market share will be faster to pass along the rate drops rathe than banks with established market share.
- In a rate increase environment, some lenders will try to take advantage of the extra demand and news of federal funds rate hikes as a way to increase rates more than they otherwise need to be increased.
Lenders will also be slow to reduce pricing for renewals of their existing portfolio because it is difficult for borrowers to determine market pricing without doing a lot of work
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