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What is a basis point?

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Used in a sentence

The Daily Ledger · Markets

The committee voted to cut rates by 25 basis points, its second reduction this year.

The reader highlighted one word mid-article. Clicked explained the finance term β€œbasis points” in plain language:

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Overview

A basis point is one hundredth of a percentage point, so 100 basis points make one percentage point and 25 basis points make a quarter of one. It is a unit of measurement, not an amount of money, and it exists so people can talk about small moves in rates and fees without being misunderstood. You meet it most often when interest rates change, since a cut is almost always announced in basis points.
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Overview

One basis point covers a hundredth of a percentage point, and stacking up a hundred of them moves a rate by a full point. It is a unit and nothing more, like a centimetre, saying nothing about how much money is at stake. It exists because percentages of percentages get confusing fast, and rate talk is full of them. 😎

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Detail

A central bank holding rates at 4% announces a cut of 25 basis points, which means the rate is now 3.75%. Reading that as a quarter of a percentage point is all the arithmetic there is, and 50 basis points would be half a point, 100 a full point. So why bother, when everyone already understands percentages? Because saying a rate fell by 1% is genuinely ambiguous: it can mean the rate went from 4% to 3%, or that it fell by one hundredth of its own value, from 4% to 3.96%. When the number being changed is itself a percentage, ordinary percentage language stops being precise, and on large sums the difference between those two readings is enormous. Basis points remove the ambiguity, because they always count in fixed hundredths of a point rather than in shares of whatever number came before. They also make small differences legible, which is why fund fees are quoted this way: 0.03% and 1.00% both read as roughly nothing, while 3 basis points against 100 basis points shows the charge is over thirty times larger.
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Detail

Your savings account pays 2% and the bank says it is bumping you 50 basis points, which lands you at 2.5%. That is the whole calculation: 100 basis points is one point, so 50 is half of one. Why not just say percent like a normal person? Because "we raised your rate 1%" could mean 2% turns into 3%, or that they nudged it to 2.02% and technically told the truth. Once the thing you are changing is already a percentage, the word percent quietly stops meaning one thing. Basis points cannot be bent that way, since they are always the same fixed slice of a point. Fees get quoted this way for a different reason: 0.03% and 1.00% both look like nothing at all, while 3 basis points sitting next to 100 basis points makes it obvious one fund is charging over thirty times more for the same job. 😎

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Analogy

Your phone battery is sitting at 40%, and someone tells you a new setting will improve it by 10%. That could mean the battery now reads 50%, ten points higher than before, or that it reads 44%, a small improvement on the 40 you had. The confusion exists because the thing being changed is itself measured in percent, so one word is doing two jobs with no way to signal which. Basis points give the number a single job: 100 basis points moves that 40 to 41, whatever the 40 happens to be measuring.
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Analogy

Games do this to you constantly. A weapon has a 20% crit chance, then a perk promises plus 10%, and now nobody knows whether that means 30% or a tenth of the 20% you already had, which lands at 22%. Both are real designs, the wikis argue about it, and the fights are always about the same thing: percent of what? Basis points are the version where the answer is written down and there is nothing to argue about. 😎
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Formal definition β€” The same term, explained the usual way

A basis point (bp) is a unit equal to one hundredth of one percent, or 0.01%, used to express changes in interest rates, bond yields, and fee levels. Its purpose is to avoid the ambiguity that arises when a percentage change is applied to a quantity that is itself expressed as a percentage, since a stated percentage change may otherwise be read as either an absolute or a relative movement.

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