What is the key factor that influences the interest rates set by banks?

The key factor that influences the interest rates set by banks is central bank policy. Central banks, such as the Federal Reserve in the United States, set benchmark interest rates that guide the lending and borrowing rates within the economy. These policy decisions are based on various economic indicators and objectives, such as controlling inflation and promoting economic growth.

When a central bank adjusts its rates, it creates a ripple effect throughout the banking system. For instance, if the central bank raises interest rates to combat inflation, banks generally increase their rates for loans and interest on deposits as a response. Conversely, if the central bank lowers rates to stimulate borrowing and investing, banks follow suit by decreasing their interest rates. This linkage makes central bank policy foundational in determining the overall interest rate environment that affects consumers and businesses alike.

Understanding the influence of central bank policy helps contextualize other factors affecting interest rates, such as operational costs, market demand, and consumer credit scores, as these are often secondary influences that occur within the framework established by central bank decisions.