Business interest rates

Monthly Statistical Bulletin Feature Articles

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:

Weighted average

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

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

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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