Prime lending rate
The prime lending rate is the optimal rate that a bank or other financial institution is willing to lend out money to its prime customers. Each bank, building society and specialist loans company sets their own prime lending rates, but in each case the prime lending rate issued is governed by the Bank of England's base interest rate.
How the base interest rate affects prime lending rates
The Bank of England is the UK's Central Bank. It is responsible for the lending of funds to the UK's banking system including high street banks and other financial institutions. In essence, the Bank of England can be thought of as the bankers' bank.
The rate at which the Bank of England lends money to its banking customers is known as the base interest rate and is set by the Bank of England's Monetary Policy Committee (MPC). The MPC meets every month to discuss the state of the UK economy and its relationship to the world's money markets. One of the central themes of the meeting is to discuss prime factors that influence the base interest rate.
The motto of the MPC is to 'maintain the integrity and value of the currency', a prime mechanism for this being the rate of inflation and how well it is performing against the government's target rate of inflation which is set annually by the Chancellor of the Exchequer. Currently, the target rate of inflation is set at +2%, and so the MPC tweaks the base interest rate to accelerate or slow the rate of inflation to keep the actual rate in line with the target rate.
As the base interest rate is the absolute rate at which lending institutions obtain funds for lending to their customers, it follows that the minimum rate at which consumer lending can be set is the base interest rate itself. However, lending institutions are in the banking business to make a profit. Therefore, the prime lending rate set by the lending institutions will be at 'x' interest rate percentage above the base rate; it normally comes out at around 0.5% to 1% above the base rate.
The prime lending rate does also vary through different lending products. For instance, the prime rate on a mortgage is going to be lower than the prime rate on a personal loan, both of which are going to be lower than the prime rate at which lending institutions will extend credit on a credit card product. These variations in the prime lending rate of different lending products is mainly driven by differences in a combination of lending costs, risk and market forces.