The Prime Rate Revisited*

The unusually wide spreads that have persisted over the last two years between the prime rate—the interest rate that banks charge on loans to their most creditworthy business customers—and money-market interest rates are now narrowing. Bankers themselves were the first to focus attention on the relationship between the prime and openmarket rates. In October 1971 a few moneycenter banks decided to link their prime rates directly to the cost of open-market funds. They adopted "formula prime rates" based on fixed relationships to the interest rate on commercial paper—specifically, the average of quoted dealer rates on paper maturing in three to four months. Commercial paper is unsecured promissory notes issued by large corporations and sold to large-volume investors. To borrowers the commercial paper market represents an alternative to bank loans.