Rates for bank to bank short term loans going up

Bank lending rate

The cost of borrowing money is going to go up for businesses. Image from Flickr.

Borrowing money always comes with some kind of cost. For businesses, banks and governments that make use of the short term loans market, the cost is set to go up. The instability in the European short term loan market is contributing to this increased rate, despite the Federal Reserve’s pledge to hold rates low.

The basics of short term loans

When a company or a bank is in need of a short term loan, they go to the unsecured loan market. In general, these markets deal in dollar loans that last up to 270 days. The bank or company pays the lender a certain percentage of what they borrow to pay for the loan. The rate for this short term loan is usually based on a rate called the “Libor” – the three-month London Interbank Rate. Currently, the Libor is 0.54 percent.

Where the rate is expected to go

While the short term capital markets have kept their rates relatively low during the recession, the rates are expected to go up. Futures markets, as well as industry observers, are estimating that the rate will go up to 0.70 percent or higher by 2011. This will make it more expensive for businesses and banks to fund their operations. Consumers will also feel the pinch as rates go up, because the availability of products and services will go down, meaning prices go up.

Why will the rate go up?

The short term loan rate is expected to go up because risk is going up. The rate of a loan is determined mostly by one factor: risk. The more risky a loan is, the more it costs. European economies, such as Greece and Spain, have been feeling the pinch lately. Because the economies in these countries are more unstable, lending money is more risky. If the rates do go up, though, then the United States Federal Reserve, which sets bank-to-bank lending rates, will be in a tough situation.