Question

Explain how'bank rate' is helpful in controlling credit creation?

Answer 1

Bank rate is the rate at which central bank offers loans to the Commercial Banks as a lender of last resort. During inflation, when supply of credit is to be reduced, bank rate is increased. This reduces borrowing by the Commercial Banks implying a reduction in their cash reserve and therefore, a reduction in their capacity to create credit. Following increase in bank rate, market rate of interest is also raised, implying a check on borrowings from the Commercial Banks. Thus, overall supply of credit is reduced in the economy. Exactly opposite is done to combat deflation: bank rate is lowered to increase the supply of credit.