Question

How do changes in bank rate affect money creation by Commercial Banks?Explain.

Answer 1

Bank rate is an instrument at the hands of RBI to control the money supply. Increase in bank rate will make the loans more expensive for the commercial banks, therefore pressurizing the banks to increase the rate of lending. The public capacity to take credit will gradually fall leading to the fall in the volume of credit demanded. The reverse happens in case of a decrease in the bank rate. The increased lending capacity of banks as well as increased public demand for credit will automatically lead to a rise in the volume of credit.