Bank rate is an important instrument to control the supply of money in the market.In this context, it may be mentioned that whenever, the bank rate is enhanced (usually by the Central Bank of any country), the tendency of the commercial banks to apply for loans reduces and the money supply also becomes stringent.
On the other hand, whenever, the Central Bank reduces the bank rate, the tendency of the commercial banks to apply for loans is also enhanced thereby giving a free flow in money supply.
Bank rate and Inflation:
The bank rate is maintained in such a way that it is able to check. When the interest rates escalate, it means that people will borrow less, expenses will be less and therefore amount saved will be more. Owing to this tendency, there is less money in the market, which checks inflation to a great extent.
A range, which is referred to as the "operating band", is established by the bank rate. This can cause the rate at which the loan is shelled out to change drastically. In fact, the so-called "overnight lending rate" may fluctuate a lot.
In this context, it may be mentioned that "overnight lending rate" refers to the rate, which is applied when various financial institutions lend as well as borrow money from each other on a "one day" basis.
Bank Rate and the Central Bank:
Changes in the bank rate and consequently the operating band are mainly trigerred by the Central Bank. By altering (increasing or decreasing) the bank rate, the course of action, which is likely to be taken by the Central Bank, is manifested. This applies for the short-term rates of interest.
Bank rate and its Impact:
Changes brought about in the bank rate means the prime rate is also likely to change. Prime rate is the interest rate, which the financial institutions impose on the customers pertaining to savings rates and other loans. Alterations in the bank rate affects interest rates on various financial instruments like deposits, investment certificates. Certain types of loans are also impacted-car loans, business loans and mortgage loans to name a few.
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Last Updated on : 30th July 2013