The interest rate that depository institutions charge each other for overnight lending
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What is the Overnight Rate?
The overnight rate refers to the interest rate that depository institutions (e.g., banks or credit unions) charge each other for overnight lending. Note that the overnight rate is called something different in different countries. For example, in the United States, it is known as the Federal Funds rate, while in Canada it is called the policy interest rate.
Breaking Down Overnight Rate
The concept of the overnight rate is closely related to banking operations and liquidity issues. The liquidity of a bank tends to significantly fluctuate due to its business operations. For example, cash withdrawals, lending activities, and other liabilities can lead to a liquidity shortage by a bank. In addition, each bank must maintain the reserve requirements set by the central bank.
Essentially, the reserve requirement is a specified percentage of the bank’s deposits that cannot be used in its lending activities. The funds must be set aside and kept in cash or on the account within the central bank. The concept of overnight lending was introduced to help depository institutions access short-term financing to meet unexpected obligations and overcome their liquidity shortfalls.
In most countries, lending rates are overseen by the central bank (e.g., the Federal Reserve in the United States or Bank of Canada in Canada). Commonly, the central bank sets a target rate or a target range for the rate. Note that central banks cannot force depository institutions operating under their jurisdiction to charge exactly the target rate in their overnight lending activities. The rates are set by the banks participating in the overnight market.
However, the central bank may encourage depository institutions to follow the interest rates within the target range through open market operations. For example, the central bank may start purchasing government bonds from the banks to inject more cash into the economy and lower the rate. Alternatively, if the central bank aims to increase the target rate, it may initiate a sale of government-issued securities to artificially create a liquidity shortage.
Overnight Rate and Monetary Policy
The overnight rate is one of the most important macroeconomic variables. Changes in the overnight lending rate may also influence other macroeconomic factors, including the unemployment rate, inflation, and economic growth rate.
Central banks manipulate the overnight lending rate to implement their monetary policies. For example, if evidence of slow economic growth emerges, the central bank can implement an expansionary monetary policy by bringing the overnight rate down to stimulate growth. A lower rate implies that the banks can borrow the funds from each other at a lower rate.
Subsequently, the banks can charge lower interest rates to their customers, making loans more affordable to businesses and individuals. Therefore, businesses are able to obtain additional funds for various investment and expansion activities while the purchasing power of consumers also increases.
Conversely, if a country’s economy is overheated and there are signs of rising inflation, the central bank may enforce a contractionary monetary policy by increasing the rate. The rate hike discourages banks from excessive overnight lending activities.
Thus, the banks will raise interest rates charged to their customers to compensate for the higher overnight rates. This leads to a decrease in money circulation in the economy, which prevents inflation. However, it also discourages business activities.
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FAQs
What Is the Overnight Rate? The overnight rate is the interest rate at which a depository institution (generally banks) lends or borrows funds from another depository institution in the overnight market. In many countries, the overnight rate is the interest rate the central bank sets to target monetary policy.
What is the current overnight Fed rate? ›
Overnight Federal Funds Rate is at 5.33%, compared to 5.33% the previous market day and 5.08% last year.
What is the target overnight rate? ›
The Overnight Lending Rate in Canada is currently 5.00%. This rate, also referred to as the Bank of Canada's policy interest rate, key interest rate, or target rate, is the benchmark cost of borrowing set by the central bank.
What is overnight call rate? ›
What is overnight call money rate? Overnight call money rates, the interest rates at which banks lend money to each other, are on the rise despite liquidity remaining in the surplus mode. Further Readings – Indian Financial System.
How much is the overnight rate? ›
Accordingly, the interest rates on the overnight deposit and lending facilities will be maintained at 6.0 percent and 7.0 percent, respectively. The Monetary Board decided to take off-cycle action to raise the BSP's Target Reverse Repurchase (RRP) Rate by 25 basis points to 6.50 percent, effective 27 October 2023.
What is the current overnight SOFR rate? ›
Secured Overnight Financing Rate is at 5.31%, compared to 5.32% the previous market day and 5.05% last year. This is higher than the long term average of 2.11%. The Secured Overnight Financing Rate or SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.
What is the prime rate today? ›
What Is the Current Prime Rate? As of May 20, 2024, the current prime rate is 8.50%, according to The Wall Street Journal's Money Rates table. This source aggregates the most common prime rates charged throughout the U.S. and in other countries. The federal funds rate is currently 5.25% to 5.50%.
What is the Fed rate today? ›
What is the current Fed interest rate? Right now, the Fed interest rate is 5.25% to 5.50%.
What is prime rate and overnight rate? ›
The prime rate is primarily influenced by the policy interest rate set by the Bank of Canada (BoC), also known as the BoC's target for the overnight rate. When the BoC raises the overnight rate, it becomes more expensive for banks to borrow money, and they raise their respective prime rates to cover the added costs.
Where can I get 7% interest on my money? ›
Why Trust Us? As of June 2024, no banks are offering 7% interest rates on savings accounts. Two credit unions have high-interest checking accounts: Landmark Credit Union Premium Checking with 7.50% APY and OnPath Credit Union High Yield Checking with 7.00% APY.
The Federal Reserve has indicated it may cut rates later in 2024. Certified financial planner Amy Hubble told CNBC Select she doesn't expect a rate cut until at least September.
What is the overnight cash rate? ›
The cash rate is the interest rate that banks pay to borrow funds from other banks in the money market overnight. It influences all other interest rates, including mortgage and deposit rates.
What is an example of an overnight rate? ›
The Overnight Rate Operating Bands
For example, if the operating band is from 2.25 to 2.75%, the target for the overnight rate is 2.5%. The top of that band, 2.75%, is the bank rate—the interest rate that the bank charges on one-day loans to LVTS participants.
What is the difference between bank rate and overnight rate? ›
The bank rate refers to the rate the central bank charges banks to borrow funds. The overnight rate, also referred to as the federal funds rate, refers to the rate banks charge each other when they borrow funds from each other. Banks borrow money from each other to cover deficiencies in their reserves.
What is the average overnight index? ›
Basic Info. Sterling Overnight Index Average (SONIA) is at 5.20%, compared to 5.20% yesterday and 4.43% last year. This is higher than the long term average of 2.74%.
What is the meaning of night rate? ›
Night Rate means the charge for work or services provided during designated off-peak hours.
What is the difference between prime rate and overnight rate? ›
A bank's prime rate is based on the Bank of Canada's overnight rate, also referred to as the policy interest rate. The overnight policy changes impact the prime rate, further affecting the interest rates of financial products, regardless of the type of interest tied to them.
What is meant by overnight index rate? ›
An Overnight Index Swap is a type of interest rate swap where the floating leg payments are linked to an overnight interest rate index.It is typically a fixed-for-floating swap, where one party pays a fixed rate and receives the floating rate, while the other party does the opposite.
