Bank Rate Policy

What is a Bank Rate?

When we talk about any rates referring to the financial system, we are talking about interest rates. Similarly, when we talk about the bank rate, it refers to the rate of interest at which a country’s central bank provides loans to other domestic banks. This can be loans to both public and private banks, but only domestic banks functioning within the fiscal bounds of the country. The bank rate also refers to the rate of interest at which domestic banks can borrow from one another, and also the rate of interest at which deposits can be made between banks. The interest rates of domestic banks increase and decrease as per the orders of the central bank so that monetary goals can be met.

For example, if a domestic bank XYZ has taken a loan from the central bank of its country, that money has to be regained from public individuals that bank with them. Thus, higher interest rates for deposits brings in a higher volume of deposits. A lower interest rate on loans brings in more demand for loans. Thus, the bank rate policy of the central government for domestic banks also influences the interest rates of the domestic banks themselves.

How do Banks decide their Bank Rate Policy?

The central bank is the regulator of the entire financial system of the country and it uses the bank rate to control inflation and money supply in the economy. Central banks decide the changes in the bank rate policy by fluctuating the interest rates for deposits and loans. This is one of the primary ways to control the financial system in the country. As overseers of the financial system, when the market forces (i.e. supply and demand) of money lose balance, adjustments and variations in the bank rate policy bring it back to equilibrium.

How Bank Rate Policy is used to control the economy? 

Lower bank rates mean that domestic banks need to pay less interest back to the central bank while repaying their loans. This means that there will be more money floating around in the economy because it is available with these banks. This, in turn, boosts the prevalence of economic activities in the country and leads to increased economic growth. Here, the bank rate policy sees an increase in the interest rate for deposits, and a decrease in the interest rate for loan repayments.

Higher bank rates, in turn, mean that there is higher interest charged on domestic bank for loan repayments. This also influences the bank rate policy of the domestic banks, thus influencing the general public in the same as well. Here, the interest rates for deposits are lower and loan repayment interest rates are higher. This prevents people from taking more loans and putting more money into the economy.

In this way, the bank rate policy of a country is used by central banks to control the economy from becoming unstable. When it begins to show sings of instability, this policy is used as a safety and preventative measure to control it and not let it get out of hand. This is one of the primary functions of the central bank of any country. In India, this responsibility falls with the Reserve Bank of India.

New Bank Policy of 2021 and 2022

The bank rate has been consistently kept at 4.25% recently and as of February 2022, it shall remain unchanged. Other bank policy that remains unchanged includes:

• Repo rate: this is rate of interest for loan repayments back to central banks by commercial banks. This is the rate primarily used to control inflation and money supply in the economy. As per new bank policy, it remains unchanged at 4%.
• Reverse repo rate: the rate of interest that the central bank pays commercial banks for their deposits. This rate also remains unchanged as of February 2022 at 3.35%.

Conclusion

All in all, the bank rate policy is an important tool in macroeconomic policy to control and regulate the financial system. Remember that the responsibility for the same falls only in the hands of the central bank of any country, which is the Reserve bank of India in our country. Repo rates and reverse repo rates are important concepts in bank policy as well. Recently, the bank rate policy has remained steady at 4.25%.