Friday, June 2, 2023

Commercial Banking Price Leadership

Banks use this money to make loans available to domestic and corporate borrowers. They then make their profits by lending at higher interest rates than the rates they pay on their deposits.

US Bank of America’s largest commercial banks, Bankers Trust Corporate, Chemical Bank, Chase Manhattan Bank, Citibank, Morgan Guaranty Trust Corporation and Wells Fargo, and many others compete with each other to provide loans to large corporate customers . The interest rates they charge corporate customers for loans are the main form of competition in this case, a price competition. When this competition becomes aggressive, the interest rates charged by them tend to fall, and hence their profits fall. A form of price leadership was instituted to avoid this aggressive competition.

The rate of interest charged by banks from large corporate customers is called prime rate. This rate is well known and often quoted in newspapers. Most of the big banks charge the same or very close to the same price for this. Frequent changes in rate are avoided to avoid volatility and competitive war. The prime rate changes when money market conditions change substantially and other interest rates rise or fall substantially.

Just then, one of the major banks announces a change to its key rate, and the other banks quickly follow suit. Banks change as leaders from time to time, but when a change is announced, other banks will immediately follow within two or three days.

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