Future Business Leaders of America (FBLA) Agribusiness Practice Test

Why is the discount rate often lower than the rates banks offer to customers?

1. It reflects the risk involved in lending

2. It is a rate set for member banks to ensure liquidity

3. It accounts for administrative costs

4. It is meant to discourage lending

The correct answer is: It is a rate set for member banks to ensure liquidity

The discount rate is lower than the rates banks offer to customers primarily because it is a rate set for member banks to ensure liquidity. When banks require additional funds to meet their reserve requirements or manage short-term liquidity needs, they can borrow from the central bank at the discount rate. This lower rate is designed to provide banks with access to funds without incurring high borrowing costs, thereby helping to stabilize the banking system and ensure sufficient liquidity in the market. By keeping the discount rate lower, the central bank encourages banks to borrow when needed, promoting lending activity and economic stability. The lower borrowing costs associated with the discount rate also serve as a buffer in times of financial stress, allowing banks to maintain operations and continue lending to businesses and consumers. In contrast, the interest rates offered to customers by banks are influenced by various factors, including the risk profile of the borrower, administrative costs, and market competition, which typically result in higher rates than the discount rate.