Interest rates and Commercial banks

Readers Question: could you please give me the likely effects of an increase level of interest rate on a commercial bank.

Readers Question: How might increased interest rates adversely affect firms, especially in the construction industry ?

If the Bank of England increased base rates, it would mean that commercial banks would find it more expensive to borrow from the Bank of England. This pushes up cost of interbank lending and usually, commercial banks will increase their interest rates by a similar amount to the Bank of England. They will increase both saving and borrowing rates, so the overall profitability of the change will be minimal.

However, commercial banks do not always follow the Bank of England base rate. This is particularly noticeable in current climate.

The Bank of England have cut base rates from 5.25% to 1.5%, but quite a few commercial banks have not passed the full rate cut onto consumers.

The reason is that Banks are short of savings and liquidity. They would rather encourage savings rather than borrowing. Also, they are trying to increase their profit margins because they have lost much in the credit crunch.

If the Bank of England increase interest rates the main effect is

• Higher cost of borrowing
• Better rate of return on savings
• Variable Mortgate interest payments increase reducing disposable income
• Increases demand for Pound as saving in UK becomes more attractive

• Interest rates explained
• Effects of Increasing interest rates