Though Other Rates Have Fallen, Prime Is Stubbornly High

When the nation’s economy slows, the Federal Reserve Board eases credit and banks help rekindle business activity by lowering the interest rates they charge for loans.

So goes a classic scenario. But this year there’s been a hitch, for banks have been unusually tardy in lowering their prime lending rate, to the surprise of economists and the dismay of some borrowers.

By most rules of thumb, “the prime should have come down weeks ago,” said David M. Jones, chief economist with Aubrey G. Lanston & Co., a big government securities dealer in New York. “But in a year of bad real estate loans and bad loans to developing countries, they must feel they’ve got reason to maximize profits.”

The prime rate is the basis for many fixed- and variable-rate loans to small and medium-sized businesses and to consumers. Banks have historically been quick to raise the prime when their borrowing costs are rising and slow to lower it when their borrowing costs decline.

The longer they delay in lowering it, of course, the more they pad their profits. And this year, they have been slower than usual, analysts agree.

The prime has declined from a peak of 11.5% last spring to 11% in June and to its current 10.5% in August. But since then it has not budged. In early November, one bank, Southwest Bank of St. Louis, cut its rate to 10%. Three weeks later, however, Southwest raised it back again.

Economists predicted on Wednesday that with recent signs of easing by the Fed, the prime could finally fall as early as next week or at least sometime during the first quarter of next year.

These economists expressed surprise that banks have not moved since last week, when the Fed signaled a further easing of credit by allowing the widely watched federal funds rate to fall to 8.25% from 8.5%. The federal funds rate is what banks charge each other for overnight loans.

By convention, banks lower the prime when it is more than 1.5 percentage points higher than their cost of borrowing. The banks’ borrowing costs--as measured by the rates they pay on 3-month certificates of deposit--are now between 8.25% and 8.5%. That’s a generous 2 to 2.25 percentage points below the prime.

“The banks feel they can keep the prime up, give special rates to their best customers and keep up their net interest (profit) margins while holding on to their market share,” said Mickey D. Levy, chief economist with First Fidelity Bancorporation, parent of Philadelphia’s Fidelity Bank.

The preferred customers who receive the preferential rates are businesses. But consumers, who receive no such breaks, are likely to face the full brunt of the higher prime, Levy acknowledged.

And by keeping the prime relatively high at year’s end, banks will help themselves in 1990 because interest rates on some adjustable consumer loans next year will be based on where rates will stand at the end of this year.

The banks’ eagerness to keep the rate high is understandable. Weakening real estate in the Northeast, Arizona and other areas has forced writedowns of loans and other defensive moves at such institutions as Bank of New England, First Interstate Bancorp in Los Angeles and Chase Manhattan Bank. Other prominent lenders, such as Manufacturers Hanover in New York, are still suffering the effects of soured loans to less developed nations.

In the third quarter, the nation’s banks as a group lost $744 million because of shaky loans on real estate and to developing countries. In the first half of the year, by contrast, the banks earned record profits.

Ken Ackbarali, an economist with First Interstate Bank in Los Angeles, said the gap between the banks’ borrowing costs and the prime actually peaked in the spring, when the prime rate began edging downward. At some points in June and July, the prime was as much as 2.35 percentage points above the banks’ costs--higher than it has been “for several years,” Ackbarali said.

Economists suggested several other reasons for banks’ reluctance to cut the rate.

The Fed has lowered rates extremely slowly this year because of its concern about inflation, which continues at an annual rate of about 4.5%. “You actually couldn’t reduce rates much slower than they have,” said S. Jay Levy of Levy Economic Forecasters in Chappaqua, N.Y.

As a result, “banks have been uncertain on the direction of short-term rates,” said Ackbarali.

Economist Jones said the prime’s “stickiness” may also be due to the fact that it is no longer the kind of rate it once was. While the prime was for many years the basis for loans to banks’ best corporate customers, it is increasingly the yardstick for consumer loans, such as auto loans and home equity loans.

As a result, banks may regard the prime increasingly as a rate that fluctuates little, like rates on credit cards and many auto loans, Jones said.