Bonus points for explaining this for my country NZ – where we have a reserve bank that set the OCR.
I think(?) globally interest rates for home mortgages have risen sharply over the last year. And I get that banks have to make a profit. Our OCR has gone from around 1% to 5% while the retail banks have gone from charging 3% to 8% (roughly pocketing the 2-3% margin) BUT where does the baseline increase go? Ie OCR was 1% now 5% so who is getting that additional 4% of interest on every bodies money??
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It’s helpful to think of the market for money like the market for basic goods sold at a retailer. Someone manufactures a product (since I associate New Zealand with wool, let’s use sweaters). Those sweaters are sold for $90 each to J.P. Morgan Sweaters, the sweater store I just invented. J.P. then sells them to customers for $100 each, pocketing a $10 profit for their services.
Banks are just retailers for money, and interest rates are the price of money. Depositors get paid a lower rate than banks charge for lending, the bank keeps the difference as profit. When interest rates go up, whomever provides the money gets paid more.
Really important point here is that banks are not borrowing from the government, and the Federal Funds Rate is absolutely 100% NOT the rate that the government (or the Fed) charges for loans. The federal funds rate is actually the rate banks charge each other for short term loans. The vast majority of bank funding comes from deposits.
Mortgages are a special case, however. Banks often don’t use deposits to make these loans. Going back to our retail example, think about a store selling sweaters on consignment. Under a consignment arrangement, the sweaters will still sit on the store shelves, but the retailer does not buy them. Instead they take a smaller cut, and only pay the manufacturer when the product sells. Similarly, most banks earn a fee for creating the mortgage, but they sell the debt to investors rather than earning the full interest for the loan. The investors are usually pension funds, university endowments, or insurance companies. These are the groups that benefit from higher interest rates.
Some boring technical points: banks can borrow money from the central bank. In the U.S. that is done at the using something called the Discount Window which is currently a 5% rate. This is notably higher than the Fed Funds rate, which is 4.65%. The Fed also pays interest on money held in deposits there.
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