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What is the Prime Rate, and why is it important?

The prime rate is the interest rate that commercial banks charge their most most creditworthy customers, usually large corporations. It’s important because it affects loan interest rates given to individuals and smaller businesses, as these rates are often set as the prime rate plus a certain percentage.

Although the Federal Reserve has no direct role in setting the prime rate for banks, many financial institutions choose to set their prime rates based partly on the target level of the federal funds rate established by the FOMC (The Federal Open Market Committee– the branch of the Federal Reserve System that determines the direction of monetary policy) This is why many people assume the Prime Rate is a rate set by the government.

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