The bank rate is the rate of interest which is charged by a central bank while lending loans to a commercial bank. Whenever a commercial bank faces any shortfall of funds, it can borrow money from the Central Bank in the form of very short term loans. It does not involve any repurchasing agreement, collateral or sale of securities.
It is an important tool used by Central Bank to manage the supply of money in the economy.
Bank rates in India are usually determined by the RBI & is usually higher than the Repo rate since it serves as a powerful tool to control liquidity in the economy.
Commercial Banks borrow the funds from the Central bank at a lower interest rate & lend these funds to the customers at higher interest rates , thereby making profits.
IMPACT OF BANK RATE CHANGES
Bank rates influence lending rates of commercial banks. A change in bank rate also affects the customers as it affects the rates at which they can take loans .
- INCREASE IN BANK RATE :- When the Central Bank increase the bank rate, it increases the cost of borrowing and hence, discourages the borrowers from taking a loan. Due to this, the process of credit creation and flow of money also reduces.
- DECREASE IN BANK RATE :- On the other hand, when the Central Bank decreases the bank rate, it encourages the borrower to take more and more loan. A high demand of loan increases the credit multiplier and credit creation process of the commercial banks.
In this way Central bank can control the situation of inflation & deflation in the economy by altering the bank rates.
CURRENT BANK RATE IN INDIA
The bank rate is changed by the RBI from time to time depending upon the prevailing economic situation.
As of Feb 2021, the Current Bank Rate in India stands at 4.25 % while the Repo rate stands at 4.00%.
Thus, in simple words Bank rate is the rate charged by the central bank for lending funds to commercial banks & serves as an important monetary tool used by the RBI to regulate the level of economic activity in a country.