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What is a Benchmark Rate?

Mary McMahon
Updated May 16, 2024
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A benchmark rate is, as it sounds, an interest rate which serves as a benchmark by which other interest rates are assessed. The benchmark rate represents the lowest interest rate, and it fluctuates in response to a wide variety of pressures. Many people use the interest rate set by central banks as a benchmark rate, with all other interest rates being pegged to this benchmark.

In the case of the interest rate set by central banks, the rate is set by government officials who periodically meet to adjust the rate, if necessary. The government wants to keep the rate low enough to promote lending and financial growth, but not so low that there is no opportunity for profit. Central banks actually set several interest rates; the rate of most interest is the rate for overnight lending.

Government securities use the benchmark interest rate to determine their rate of return. The rate of return on such securities is low, but they are also low-risk, because they are backed by the government. Interest rates for other types of securities are higher, potentially generating more returns although they are also associated with more risks. When interest rates are set, people consider the benchmark interest rate, as potential purchasers of securities will not buy products yielding low interest.

Benchmark rates are also used by banks and other lenders to determine interest rates for their financial products, such as credit cards, home loans, and car loans. Historically, banks used the benchmark interest rate to determine the prime rate, the lowest interest they offered, and interest was offered in terms of the prime rate plus an additional percentage. For low-risk borrowers, a loan at prime rate might be obtainable, while high risk borrowers would have had to take a higher rate. Today, the prime rate and benchmark rate can differ.

Even for people who are not planning on investing or taking out a loan, it can be beneficial to pay attention to the benchmark rate and its fluctuations. Most newspapers announce changes in the rate, as do news broadcasts. Changes in the rate can be warning signs that the government is concerned about the flow of funds; if the rate is dramatically reduced, for example, it indicates that officials are worried about a credit freeze. If the rate is raised, it can indicate that an economy is in good condition, so the government has no worries about incentivizing lending.

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Mary McMahon
By Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

Discussion Comments
By julies — On Jun 30, 2011

It is a good idea to know that the Benchmark Rate is any time you are going to be doing something that might affect interest rates. When we were looking to finance our house, this is something we considered and helped give us an overall feel for the market.

The Benchmark Rate is not the same as the prime interest rate, but it is helpful to know the difference and know how they are affected. The reason you get such a low rate of return on investments that are backed by the government is because there is not much risk involved.

By BabaB — On Jun 29, 2011

Big banks usually use the benchmark lending rate to offer to the best business customers. So some business owners, and I suppose some rich individuals, get a special deal when they need to borrow money.

These bank customers have usually proved themselves to be trusted, low-risk borrowers.

If the bank feels like a business customer does not have a good history of paying back loans, he is high-risk, and will probably have to pay a higher interest rate.

By live2shop — On Jun 29, 2011

Understanding interest rates can be very complicated for a lot of people. I'm just starting to get a feel for how it works. Unless you are in a business where you need to know what the interest rate is on a daily basis, it doesn't seem necessary to pay attention to it. Some examples would be bankers, brokers,financial lawyers,and real estate people -knowing the rates is part of their job.

But the average person just doesn't have a need to know the interest rate unless you are buying a house, or buying a financial product, like certificates of deposit or treasury bills.

I didn't know that people in the government got together to decide whether to reset the interest rate. They are trying to keep rates low enough so there will be lending, but if rates are set too low, profits are hard to make.

So, the benchmark rate is the foundation and then banks,and government can set their own rate above that benchmark. When shopping for banks lately, I have noticed there is quite a difference in the rates different banks offer. I don't quite understand why that's so.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a...

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