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.