Bank Rate vs Policy Rate: What Is the Difference?

The term “bank rate” has different meanings depending on the central bank and the era. In some systems, bank rate versus policy rate difference is minimal—the bank rate is the policy rate. In others, they are distinct: the bank rate (the discount window lending rate) sits above the policy rate (the target for overnight inter-bank loans). Understanding which is which prevents confusion about how tightly central banks control short-term interest rates.

The U.S. Federal System: Two Distinct Rates

In the United States, bank rate and policy rate refer to different interest rates, though they are closely linked.

The policy rate is the federal funds rate—the target rate for overnight loans between commercial banks. The Federal Reserve does not directly set this rate; instead, it sets a target band (e.g., 1.00–1.25 percent) and conducts open-market operations (buying and selling securities) to nudge the actual overnight rate toward that band. The federal funds rate is the key rate that signals the Fed’s monetary stance to the entire economy.

The bank rate is the discount rate—the rate at which the Federal Reserve lends directly to commercial banks through its discount window. This rate sits structurally above the federal funds rate target. When the Fed sets a target FFR band of 1.00–1.25 percent, the discount rate might be 1.75 percent (50 basis points above the upper bound). This spread is deliberate: the Fed wants to discourage banks from relying on the discount window and instead borrowing from each other in the federal funds market.

The bank rate is thus a penalty rate. It exists to keep banks motivated to borrow cheaper funds from their peers. During normal times, the discount window is rarely used; banks borrow from each other because the federal funds rate is lower. In a crisis—when inter-bank lending freezes and banks cannot find counterparties—the discount window becomes a backstop. The penalty rate disappears, and the Fed may lend at or below the federal funds target to stabilize the system.

The Bank of England: Unified Term

The Bank of England uses the term bank rate to mean its base rate, the equivalent of the Federal Reserve’s policy rate. There is no separate “bank rate” lending facility; the term itself is the official policy rate.

The BoE sets the bank rate via its Monetary Policy Committee. This single rate anchors short-term interest rates throughout the UK financial system. Commercial banks set their own lending and borrowing rates as spreads (markups or markdowns) relative to the bank rate. When the BoE raises the bank rate from 3 percent to 3.5 percent, UK mortgage and deposit rates adjust accordingly.

In this system, there is no distinction between “bank rate” and “policy rate”—they are synonymous.

The European Central Bank: Main Refinancing Rate

The ECB’s primary policy rate is the main refinancing rate—the rate at which the ECB lends to commercial banks in weekly auctions. This is the ECB’s equivalent of the U.S. federal funds rate. The term “bank rate” is rarely used in ECB communications; the institution prefers “main refinancing rate” to avoid confusion.

The ECB also sets a standing deposit rate (currently negative in some periods) at which banks can place excess cash overnight, and a marginal lending rate (the penalty rate) at which banks can borrow overnight. These corridor rates guide the overnight market. The main refinancing rate sits in the middle.

Why Terminology Matters

The confusion between “bank rate” and “policy rate” arises because:

1. Historical usage varied. In older central banking literature, “bank rate” often referred to what is now called the “base rate” or “policy rate.” The Bank of England retained this terminology.

2. Jurisdictional divergence means that a single term has different definitions in different countries. A financial analyst must always specify which central bank is being discussed.

3. Structural differences in how central banks implement policy. The Federal Reserve achieves its target through open-market operations in federal funds, not through direct lending. The ECB and BoE rely more heavily on standing facility rates and refinancing operations.

The Hierarchy of Rates

In most modern systems, there is a hierarchy:

• The policy rate (or target rate) is the official signal of monetary stance.
• The bank rate (where it exists as a separate entity) is a lending rate above the policy rate, serving as a backstop.
• Deposit rates and lending corridor rates create a band around the policy rate, keeping overnight markets functioning.

During normal times, the policy rate dominates attention. When a central bank announces a rate cut or hike, it is moving the policy rate. The bank rate adjusts mechanistically—it stays a fixed number of basis points above the policy rate.

During crises, the bank rate becomes crucial. It signals that the central bank will lend freely to solvent banks at a known cost. By lowering the bank rate (or narrowing the spread to the policy rate), the central bank signals that it is easing credit and stepping in as a lender of last resort.

Modern Convergence

Many contemporary central banks have begun using unified language. The Federal Reserve increasingly refers to its target as the “federal funds rate” rather than distinguishing “policy” from “bank” rates. The ECB avoids “bank rate” entirely. The Bank of Canada calls its target the “policy interest rate,” not “bank rate.”

This convergence reflects a move toward clarity: central banks prefer to announce a single target rate and make adjustments to it, rather than managing multiple rates in a corridor.

Historical Echoes

The distinction between policy rate and bank rate has echoes in how central banks are described colloquially. When someone says, “The central bank raised rates,” they mean the policy rate. When financial markets worry about “the cost of funding,” they are often concerned about the lending rates that sit above the policy rate—closer to the old “bank rate” concept. These colloquial usages do not always align with official definitions.

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