Manufacturers Hanover Trust Co., the fourth-biggest bank in the nation, yesterday lowered its prime lending rate from 10 3/4 percent to 10 1/2 percent, reflecting the continuing easing of Federal Reserve Board monetary policy.
Patrick G. Hartley, senior vice president and chief financial officer of the National Bank of Washington, said he expects other banks to follow Manufacturers Hanover's lead within a few days and he predicted further cuts in the prime rate within a short time.
The quarter-point cut in the key business lending rate, which stood at 13 percent several months ago, gave a late boost to the stock market. Stock prices began a steady climb after noon, then jumped in late trading on the promise of lower rates.
The Dow Jones industrial average -- probably the most-closely-watched stock market indicator -- closed the day at 1,234.54. The average was up 16.45 points on the day, and about half the gain occurred during the final hour of trading.
The Federal Reserve, anxious to insure continued economic growth and less concerned about a renewal of inflation than it has been in years, has taken actions in recent months to foster a decline in interest rates and a growth in funds that banks can lend. Rates in the open market, where banks borrow most of their funds, have declined about 3 percentage points since September.
John Meyers, a spokesman for New York-based Manufacturers Hanover, said a "prime rate at 10 1/2 percent is a more accurate reflection of our lower cost of funds, and we are passing it along to our customers."
The prime rate is the interest banks charge their best business borrowers for loans of about 90 days to a year and is the rate on which most other business borrowing charges are based. The rate on most business loans rises and falls in tandem with changes in the prime rate.
The cut was expected. The prime has fallen only 2 1/4 percentage points in the last four months, while open market rates have tumbled about 3 percentage points.
Banks generally reduce their rates more slowly than the cost of their funds declines to recoup profits lost during periods of rising interest rates -- when the rise in bank lending charges generally does not keep pace with the increase in open market rates. Banks raise most of their funds in the so-called open market by selling certificates of deposit and buying federal funds. Federal funds are overnight loans made by banks with excess reserves to other banks that don't have enough funds to settle their account with the Federal Reserve. Rates for federal funds and 90-day certificates of deposit are about 8 percent.
Besides the normal desire to regain lost profits, federal regulators are another source of pressure on banks to go slow in lowering interest charges to borrowers. Regulators want banks to strengthen their balance sheets during a period in which many loans are shaky despite two years of recovery. As a result, the spread between banks' costs of raising funds and the prime rate is wide by historical standards. Normally the spread is about 200 basis points (a basis point is one one-hundredth of a percentage point). Even at the lower prime announced by Manufacturers Hanover yesterday, the spread is 250 basis points, and at most banks it is 275.
National Bank of Washington's Hartley said that, without a further decline in open market interest rates, the prime should get down to about 10 percent in the near future.