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BANK RATE POLICY FORMULATON UNDER RBI
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BANK RATE POLICY FORMULATON
UNDER RBI
AUTHORED BY - MEHUL
DHARMENDRA SHAH
P.E.SOCIETY’S, MODERN LAW
COLLEGE
GANESHKHIND UNIVERSITY
CIRCLE, PUNE
Abstract:
The RBI regularly controls the level of credit supplied by the
commercial banks by changing the bank rate. When Bank rates changes it suddenly
impacts on Economy. When RBI decrease bank rate it is called 'cheap money
policy'. Money supply in the economy is increased. When RBI increases bank
rate, it is called 'dear money policy'. Money supply in the economy is
decreased. RBI uses bank rate to balance economic growth and inflation. This
paper examines Changing bank rates & its impact on Indian economy. This paper
Researcher has tried to find out extent changing bank rate facilitated impact
on Indian economy.
Introduction:
Bank rate is the rate at which banks borrow money
from the central bank without any sale of securities. It is usually for a
longer era of time. The RBI has the control to raise or decline the bank rate.
The RBI regularly controls the level of credit supplied by the commercial banks
by changing the bank rate. The commercial banks make loans by discounting bills
of exchange accessible to them by companies and merchants. Now if commercial
banks do not get sufficient deposit they move toward the RBI for funds and the central
bank re-discounts the bill of exchange detained by commercial banks. An
increase in the bank rate by the RBI implies that the commercial banks will
have to pay higher interest rates while taking loans from the RBI. They will,
so, be required to charge higher rates of interest while making loans. When the
RBI increases the bank rate, the commercial banks are forced to pay higher
interest rates on the deposits they accept from the public. This also explicates why the commercial banks
charge higher rate of interest, while making loans and advances, when the bank
rate increases. There is, in reality, an involuntary relation between the bank
rate & the market rate. This means
that as and
when the bank
rate increases the market rates of interest automatically raise. The
converse is also true. When the central bank decreases the bank rate the
commercial banks decrease their lending
rates. This means that the market rates
of interest involuntarily fall. When
the market rates
of interest increase,
firms and consumers of durable
goods will be less ready to take loans from banks than before & business
people finds it less money-making to borrow funds for investment purposes. The
banks are also less ready to make loans. It is because if they build more loans
they have to move toward the RBI for funds. And the RBI will charge
higher rate of interest from commercial banks for making loan.
Therefore two things happen when the bank rate increases. First, the market
rates of interest increases & the demand for
bank loans decrease
& Secondly, commercial banks
have to get funds from the central bank by paying higher
rates of interest.
For both the reasons
the commercial banks make
less loans when
the bank rate increases. The converse is also true. The
commercial banks make more loans in the event of a fall in the bank
rate. This explains why the bank rate is increased during inflation and is decreased
during deflation (recession).
Bank Rate
Definition:
The Bank Rate meaning is the interest
rate of financial institutes at which India’s central bank, the Reserve Bank of
India (RBI), provides loans to domestic or commercial banks without collateral.
- The Reserve Bank of India determines the Bank
Rate, which is declared at the monetary policy review that is conducted
bi-monthly.
- The bank rate is in accordance with the
primary goal of meeting the inflation targets.
- The current bank rate as determined by the
Reserve Bank of India is 6.75%.
Bank Rate
Policy and Marginal Standing Facility (MSF) rate have a link, and when the MSF rate changes, so does the Bank Rate.
The Reserve Bank of India decides the Bank Rate. This rate is slightly higher
than Repo Rate. The bank rate meaning states that the interest rate charged to
the commercial and financial banks of India by the head of the financial
institutes, Reserve Bank of India.
The RBI, in
its monetary policy review, determines the Bank Rate based on the entire
situation of the overall economy. The Reserve Bank of India lends large funds
to commercial banks at this rate.
The Reserve
Bank of India is the main authority determining the bank rate, it is altered
frequently. Though, there is no prescribed or fixed schedule for the alteration
of the Bank Rate.
Types of Bank
Rates in India :
The Monetary Policy Committee (MPC) requires a mixture of
different bank rate policies to keep the Indian economy from slipping
into the den of inflation. There are different types of bank rates in
India contributing to the MPC’s attempts. They are explained below.[1]
1. Repo Rate
and Reverse Repo Rate
Bank rate
and repo rate are similar terms and often confuse one another. The repo
rate, an abbreviation of Repurchase Agreement or Repurchasing Option, is the
rate at which the RBI provides commercial banks with loans against government
securities. In this case, the banks will purchase the securities from the RBI.
The RBI attempts to propel the cash liquidity or drain the excess by changing
the repo rate. The current repo rate (dated January 7, 2023) is 6.25%. The
reverse repo rate can be the reverse of the repo rate. It is the rate at which
commercial banks lend funds to the RBI. This instrument helps control inflation
as the excess of funds with commercial banks is borrowed by the RBI and
returned with the charge as and when the banks require. The current reverse
repo rate (dated January 7, 2023) is 3.35%.[2]
2. Statutory
Liquidity Ratio (SLR)
A
commercial bank must retain a percentage of liquid cash, gold or other
securities as deposits. This is known as Statutory Liquid Ratio or SLR and is
controlled by the RB. In essence, it is the minimum amount of reserves that
banks must have to extend credit to clients and are held by the banks
themselves, not the RBI. The convenient tool, SLR, is used by the Monetary
Policy Committee (MPC) to regulate inflation, credit expansion, and liquidity
flow and was established as per Section 24 (2A) of the Banking Regulation Act
of 1949. The SLR on January 7, 2023, is 18.00%. [3]
3. Cash Reserve
Ratio (CRR)
Cash
Reserve Ratio (CRR) is a percentage of deposits required by commercial banks to
be maintained in the form of liquid cash with the RBI as reserves. Unlike SLR,
banks do not keep a balance with themselves. The CRR contributes to determining
the base rate and is a part of the RBI’s monetary policy. It is also a measure
by the RBI to control the cash flow in the Indian economy. The CRR as on
January 7, 2023, is 4.50%.[4]
4. Marginal
Standing Facility Rate (MSF)
Marginal
Standing Facility (MSF) is a facility extended to commercial banks by the RBI
in the event of an emergency to obtain liquidity overnight. The option is
available to the banks of the inter-bank liquidity is dried up. Under the
Liquidity Adjustment Facility or LAF, banks borrow from the RBI by pledging
government securities at a rate higher than the repo rate. The MSF rate is set
at 100 basis points, or one percentage point, above the repo rate. Under MSF,
banks can borrow up to 1% of their Net Demand and Time Liabilities (NDTL). The
MSF rate as on January 7, 2023, is 6.50%.[5]
5. Lorenz Curve
A Lorenz
curve is a graphical representation of income or wealth inequality developed by
American economist Max Lorenz in 1905. The graph depicts population percentiles
based on income or wealth on the horizontal axis and cumulative income or
wealth on the vertical axis.[6]
6. Non-Performing
Assets (NPAs)
A
non-performing asset (NPA) is a loan or advance on which the principal or
interest payment has been late for 90 days. Banks are required to categorise
NPAs further as the following.
·
Substandard Assets: Assets that have
been NPA for less than or equal to 12 months.
·
Doubtful Assets: An asset is
questionable if it has been in the substandard category for 12 months.
·
Loss Assets: According to the
RBI, a loss asset is considered uncollectible and of such low value that its
continued existence as a bankable asset is not warranted, even if there may be
some salvage or recovery value.[7]
Traditional Approach and Todays Approach:
1. Traditional approach: -
Bank rate means on which central bank
discounts and rediscount the eligible bills.
2. Today's approach: -
Bank
rate means the minimum rate on which central bank provides financial accommodation
to commercial bank in the discharge of its function as the lender of the last
resort.
Determination of Bank Rate
Section 49 of
the Reserve Bank Of India Act 1934 determines and regulates the Bank rates.
- The Reserve Bank of India (RBI) is the
authority in India to determine the Bank Rate.
- The RBI in its bi-monthly monetary policy
review announces the bank rate based on the macroeconomic situation.
- The Bank Rate is announced keeping in mind the
primary goal of inflation targeting.
- If the Bank rate is decreased then it
increases the money supply in the economy as the banks borrow and lend it
to customers. On the other hand, if the Bank rate is increased it will
inhibit the money supply in the economy.[8]
As of February
2023, the latest Bank Rate from RBI is 6.75%. The RBI determines this rate and
other rates such as Repo Rate and Reverse Repo Rate. The current Repo Rate is
6.50%, and the Reverse Repo Rate is 3.35%. These rates may change due to
changes in the MSF rate and prevailing economy from time to time. Section 49 of
the Reserve Bank Of India Act 1934 regulates and determines the Bank Rate. The
Reserve Bank Of India executes the monetary policy review bi-monthly in which
the bank rate is declared by the officials depending on the macroeconomic
situation of the country.
Factors while
determining Bank Rate in India
The Reserve
Bank of India (RBI) takes into consideration several factors when determining
the Bank Rate. These factors include:
1.
Inflation
The RBI
assesses the prevailing inflation rate and its outlook. Higher inflation may
prompt the RBI to raise the Bank Rate to curb inflationary pressures.
2.
Economic Growth
The RBI
considers the state of economic growth and overall macroeconomic conditions.
The Bank Rate may be adjusted to stimulate or moderate economic activity based
on growth objectives.
3.
Monetary Policy Objectives
The RBI aligns
the Bank Rate with its monetary policy objectives, which include price
stability, growth, and financial stability. The rate is set to achieve these
objectives effectively.
4.
Market Conditions
The RBI
analyses market conditions, including interest rate levels, credit demand,
liquidity, and investor sentiment. These factors influence the decision on
adjusting the Bank Rate. The frequency of changes to the Bank Rate depends on
the prevailing economic conditions and monetary policy stance. The RBI may
choose to change the Bank Rate during its periodic monetary policy review
meetings, typically held every two months. However, the RBI can also make
off-cycle changes if there is a need to address emerging economic challenges or
maintain policy effectiveness. The timing and frequency of Bank Rate changes
are determined by the RBI based on its assessment of the economic situation and
policy requirements.
Impact Of Bank Rate :
The Bank Rate policy depends on the MSF rate, and
when the Reserve Bank of India increases the Bank Rate, the commercial bank
borrows the funds at a higher price and reduces the credit volume. When the
Bank Rate rises, banks experience a decline in the money supply. The Bank Rate
is determined keeping into consideration the primary goals of attaining
the inflation targets. If the bank rate is reduced then the
economic flow in the country increases, on the other hand, if the bank rate
surges the economic flow in the country decreases.
Bank Rate Vs Repo Rate :
The significant
difference between the Bank Rate and Repo Rate is that the Bank rate directly
impacts customers since it impacts long-term funds lending. In contrast, Repo
Rate doesn’t impact the customer directly.
The Reserve Bank Of India
applies Repo Rate to the repurchase of securities sold by commercial banks and
the Bank Rate to loans that the RBI gives to commercial banks.
The Repo Rate is lower
than the Bank Rate due to the collateral and repurchase obligation. The Reserve
Bank of India provides Repo Rates on short-term financial lending to banks
while Bank Rates issues to long-term requirements of domestic banks.
Bank
Rate vs. Overnight Rate
The
discount rate, or bank rate, is sometimes confused with the overnight rate.
While the bank rate refers to the rate the central bank charges banks to borrow
funds, the overnight rate—also referred to as the federal funds rate—refers to
the rate banks charge each other when they borrow funds among themselves. Banks
borrow money from each other to cover deficiencies in their reserves.
Banks
are required to have a certain percentage of their deposits on hand as
reserves. If they don't have enough cash at the end of the day to satisfy their
reserve requirements, they borrow it from another bank at an overnight rate. If
the discount rate falls below the overnight rate, banks typically turn to the
central bank, rather than each other, to borrow funds. As a result, the
discount rate has the potential to push the overnight rate up or down.
As the
bank rate has such a strong effect on the overnight rate, it also affects
consumer lending rates. Banks charge their best, most creditworthy customers a
rate that is very close to the overnight rate, and they charge their other
customers a rate that is a bit higher.
For
example, if the bank rate is 0.75%, banks are likely to charge their customers
relatively low-interest rates. In contrast, if the discount rate is 12% or a
similarly high rate, banks are going to charge borrowers comparatively higher
interest rates.[9]
How
to Calculate Bank Rates?
The central financial authority of the nation charges an
interest rate that is directly related to the money supply of the entire
economy. Hence, the Reserve
Bank of India (RBI) controls and determines the bank rate in India.
The RBI has several tools to regulate the supply of money and credit in the
economy, including the repo rate, reverse repo rate, and the
Cash Reserve Ratio (CRR).
Furthermore,
when there is a change in the bank rate, there is a significant influence on
the entire economy. For instance, the stock market prices can change when
fluctuations in the bank rate occur. Moreover, these changes in interest rates
also affect the customers who borrow loans from financial institutions.
Bank
Rate Policy :
The
Bank rate policy denotes the policy by which the Reserve Bank of India (RBI),
the country’s central bank, regulates the supply of money and credit in the
economy. As you know, the bank rate is the rate of interest at which banks
borrow funds from the RBI. Hence, changes in this interest rate not only affect
the banks but also the rest of the economy.
Furthermore, the Reserve
Bank of India has the power to increase or decrease the supply of money in the
country. When they wish to increase the money supply, RBI decreases the bank
rate. On the contrary, to decrease the money supply in the economy, RBI increases
the rate of interest for banks. Therefore, we can conclude that the bank rate
policy is one of the key monetary tools used by the central financial
institution of India to achieve its economic goals.
How does the RBI use its
bank rate?
The RBI uses its bank rate to set the minimum amount a
bank must pay its customers who park money with it. Banks use these funds to
make loans and other investment opportunities for themselves and their clients;
in practice, the bank rate directly impacts the loan rate offered by banks (to
businesses and consumers). As is usually the case when regulators alter rates
to change monetary policy, lowering the bank rate helps stimulate spending in a
given economy as lower interest rates mean borrowing money becomes more
affordable for everyone from individuals to small businesses. Raising rates has
an opposite effect—it makes lending money more expensive, which tends to slow
economic activity and can lead to unemployment.
Movements in Bank Rate during 2013-2023
1) 2013 :
Over 6 per
cent points decline in inflation since late 2013.
2) 2014 :
Strategic
headed for added moderation command be there facts to authenticate abiding disinflationary
pressures. Besides analytical would be there sustained prohibitive class financial consolidation 23
satisfactorily in the role of steps toward overcome resource constraints in
addition to promise availability of major inputs such for example power, land,
natural resources plus infrastructure.
3) 2015 :
The Bank Rate
stands adjusted by 50 basis points from 8.25 per cent to 7.75 per cent
captivating benefit of reduction inflation to increase growth in an economy
that hasn't been able to getaway global headwinds. The Bank Rate stands adjusted by 25 basis
points from 8.5 per cent to 8.25 per cent with effect from June 2, 2015.Corporate
earnings boast been depressing; growth happening bank lending has been the
insignificant here about two decades. The Bank Rate stands adjusted by 25 basis
points from 8.75 per cent to 8.5 per cent with effect from March 4;
2015.Government has certainly paid consideration to the quality of fiscal
adjustment. Aggressive rate cuts are not promising participating in this time
for the reason that they obtain by now signed the Memorandum of Understanding along
with the RBI going on supple inflation targeting. Furthermore, inflation is on
the midpoint level. The Bank Rate stands
adjusted by 25 basis points from 9.0 per
cent to 8.75 per cent
with effect from January
15, 2015.The fifth bi-monthly
monetary policy statement
moreover confirmed to
facilitate a long
time ago the pecuniary
strategy stance shifts,
succeeding guidelines
procedures determination stay uniform plus
this stance. Type near auxiliary respite is statistics with the purpose
of make firmer ongoing
disinflationary pressures. and unsympathetic
would be present sustained lofty condition financial consolidation in the same
way as positively being steps in the direction of overcome fund constraints
along with reassure availability of
key in inputs
such while power, land, mineral deposits after that
infrastructure. The final would transpire wanted on the road to make sure with
the aim of probable yield rises more than the projected pick-up in
vogue lump participating in introduction quarters accordingly since
toward have inflation.
4) 2016 :
DR. URJIT
R. PATEL maiden policy of announcement facilitates RBI
Governor. This was
the Central bank's fourth
bi-monthly document statement
during give preferentiality of the while 2016-17. In its policy statement, the inner earlier
believed so as to the verdict of the
fiscal guidelines board was
unfailing among the accommodative stance of the pecuniary policy. Retail
inflation is estimated toward transpire 5 apiece cent before strut 2017 along
with upside risk.
5) 2017 :
As announced in
the Third
Bi-Monthly Monetary Policy Statement 2017-18 dated August 02, 2017, the Bank Rate stands adjusted by 25 basis points from
6.50 per cent to 6.25 per cent with effect from August 02, 2017.[10]
6) 2018 :
As announced in the Third Bi-Monthly
Monetary Policy Statement 2018-19 dated August 1, 2018, the Bank Rate stands
adjusted by 25 basis points from 6.50 per cent to 6.75 per cent with immediate
effect.[11]
7) 2019 :
As announced
in the First Bi-Monthly Monetary Policy Statement 2019-20 of April 04, 2019,
the Bank Rate is revised downwards by 25 basis points from 6.50 per cent to
6.25 per cent with immediate effect.[12]
8) 2020 :
Accordingly,
the marginal standing facility (MSF) rate and the Bank Rate stand reduced to
4.25 per cent from 4.65 per cent. Since the MPC met in March
2020, global economic activity has remained in standstill under COVID-19
related lockdowns and social distancing. Among the key advanced economies
(AEs), economic activity contracted in the US, Euro area, Japan and the UK in
Q1:2020. Among emerging market economies (EMEs), the Chinese economy went into
a pronounced decline and data on high frequency indicators suggest that
activity may have also shrunk in other EMEs such as Brazil
and South Africa.[13]
9) 2021 :
Due to COVID19
era the marginal standing facility (MSF) rate and the bank rate remain
unchanged at 4.25 per cent.[14]
10) 2022 :
As announced
in the Monetary Policy Statement 2022-23 dated December 07, 2022, the Bank Rate
is revised upwards by 35 basis points from 6.15 per cent to 6.50 per cent with immediate effect.[15]
11) 2023 :
As
of February 2023, the latest Bank Rate from RBI is 6.75%.[16]
Conclusion:
The bank rate can be compared to a quarterback charging at inflation.
Banks seek loans from the RBI to maintain liquidity and meet reserve requirements.
In response to the global crisis, many central banks altered their interest
rates to stimulate and stabilise the economy. We hope you understand the
economic term- bank rate.
bank rate is the interest rate charged by a country's central bank to
financial institutions when they borrow money. To meet reserve requirements and
preserve liquidity, banks turn to the central bank for loans. The interest
rates charged by central banks are designed to keep the economy stable.
Bank rate is a weapon of the monetary authority and playing the role of
a reference rate. The bank rate is a powerful tool for central banks because it
can have a significant impact on the economy. By changing the cost of borrowing
money, central banks can influence spending, investment, and inflation. This,
in turn, can help to maintain economic stability and promote growth.
References:
1.
Reserve Bank of India
https://m.rbi.org.in › scripts › BS_P...Press Release
2.
Governor's Statement, June
4, 2021 - Reserve Bank of India
3.
DOR.RETREC.70/12.01.001/2022-23
dated September 30, 2022
4.
Reserve Bank of India
https://www.rbi.org.in › scripts › BS... Press Release
5.
circular
DBR.No.Ret.BC.58/12.01.001/2016-17 dated April 06, 2017
6.
circular DBR.No.Ret.BC.107/12.01.001/2017-18
7.
RBI/2018-19/162
DBR.No.Ret.BC.33/12.01.001/2018-19
[1] https://www.urbanmoney.com/banking/what-is-bank-rate
[2] https://www.urbanmoney.com/banking/what-is-bank-rate
[3] Abid
[4] Abid
[5] https://www.urbanmoney.com/banking/what-is-bank-rate
[6] Abid
[7] Abid
[8] https://prepp.in/news/e-492-bank-rate-indian-economy-notes
[9] https://www.investopedia.com/terms/b/bankrate.asp
[11] circular DBR.No.Ret.BC.107/12.01.001/2017-18
[12] RBI/2018-19/162 DBR.No.Ret.BC.33/12.01.001/2018-19
[13] Reserve Bank of India https://m.rbi.org.in › scripts ›
BS_P...Press Release
[14] Governor's Statement, June 4, 2021 - Reserve
Bank of India
[15] DOR.RET.REC.70/12.01.001/2022-23 dated September 30, 2022
[16] Reserve Bank of India https://www.rbi.org.in › scripts › BS...
Press Release
Article Information
BANK RATE POLICY FORMULATON UNDER RBI
Authors: MEHUL DHARMENDRA SHAH
- Journal IJLRA
- ISSN 2582-6433
- Published 2024/04/07
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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