Feature Article—Business interest rates
In the January 2008 Reserve Bank of Australia (RBA) Bulletin changes were made to business interest rate statistics. These changes impact on
a regular statistic published in the Parliamentary Library’s Monthly Statistical
Bulletin.
This feature article explains the changed methods,
results and how the Monthly Statistical Bulletin will report business interest
rates from this edition.
Different methodologies
Historically, the RBA has published the ‘large business
variable indicator rate’. This interest rate has traditionally been referred to
as the ‘prime rate’. The prime rate is reflective of how much creditworthy
large businesses could expect to pay for loans from banks. The statistic
published by the RBA was the average prime rate available within a reporting
period—usually one month.
In the January RBA Bulletin, the prime rate was
ceased in favour of a ‘weighted average interest rate on credit outstanding’. The
reason the RBA changed the statistic is that ‘the large business variable
indicator rate … is no longer representative of large businesses’ funding costs’.
The new interest rate is reflective of the cost of servicing loans, on all debt
outstanding.
The simple difference between the rates is that the
prime rate records a rate available today for new debt, while the
weighted rate covers actual debt servicing interest costs on existing debt.
Calculation of weighted interest rate
To generate the weighted rate, the RBA sorts each outstanding
business loan according to the size of the loan—to determine business size—and
the rate at which the loan is priced. The number of loans at an interest rate
is then used to calculate a weight to apply to that interest rate. This is done
for all interest rates to calculate a weighted average rate. Algebraically, the
calculation of the rate is:
Where Li is the number of loans with
interest rate ri and L is the total number of loans. The sum (S) of all such relationships gives a weighted average interest rate.
Difference in results and interpretation
The change in series means the prime rate is quite
different to the weighted rate, because of the range of business debts at
different rates, expiring at different points in the future.
Graph 1 shows the distribution of large business loans
by interest rate used in the RBA’s calculation. This graph shows the majority
of outstanding loans to large business are priced between 6.5 and 8.5 per cent.
For these data, business size is determined by loan
size. Large businesses have loans of $2 million or more.
Graph 2 demonstrates the difference in the rates in
practice, by plotting the prime rate and large business weighted average rate
data from December 1978 until November 2007.
Graph 1. September 2007 distribution of large business
interest rates
Until December 1993 there is no difference in the data
recorded by the RBA. From December 1993 until the most recent results, there is
a clear divergence between the prime and the weighted rates. The weighted rate has
been lower than the prime rate because of the perseverance of cheaper credit
products, compared to higher interest rates on new borrowings in the current
market place. As cheaper credit products expire and higher cost credit becomes
prevalent, it is likely the weighted rate will increase.
Graph 2. Prime rate compared to the large business
weighted rate
Monthly Statistical Bulletin Table 5.1
As a consequence of the change, Table 5.1 in the Monthly
Statistical Bulletin will report a large business weighted average rate rather
than the prime rate. The real prime rate has also been dropped in preference to
the similarly constructed weighted rate for small businesses. Small businesses are
defined as those with loans less than $2 million.
Adrian Makeham-Kirchner
Statistics and Mapping Section
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