Explain how 'Repo Rate' can be helpful in controlling credit creation.
The rate of interest
at which the RBI (Central Bank) gives short term loans to commercial banks is
called Repo Rate.
The Central Bank makes use of Repo Rate to control
the supply of money and credit creation. A rise in Repo Rate would make
borrowings by commercial banks costly. This increase forces these banks to
raise the interest rates on lending to the general public.
As borrowings from banks become costly, it leads to a decline in demand for
borrowings from the banks, which decreases credit creation in the economy.
On the other hand, a fall in Repo Rate encourages banks to keep small
proportion of their deposits as reserves since borrowing from the Central Bank
is now less costly than before. This increases credit creation in the economy.
If
the Central Bank aims at expansionary monetary policy, then it at first
instance reduces the Reverse Repo Rate, which in tum makes the lending
unattractive and discourages the Commercial Banks to lend to the Central Bank.
Thereby, a fall in the reverse repo rate restricts the flow of money and credit
in an economy.
The rate of interest at which the RBI (Central Bank) gives short term loans to commercial banks is called Repo Rate.
The Central Bank makes use of Repo Rate to control
the supply of money and credit creation. A rise in Repo Rate would make
borrowings by commercial banks costly. This increase forces these banks to
raise the interest rates on lending to the general public.
As borrowings from banks become costly, it leads to a decline in demand for
borrowings from the banks, which decreases credit creation in the economy.
On the other hand, a fall in Repo Rate encourages banks to keep small
proportion of their deposits as reserves since borrowing from the Central Bank
is now less costly than before. This increases credit creation in the economy.
