Question

How Is 'bank rate' used by central bank in influencing credit creation by commercial banks? Explain.

Answer 1

The rate at which commercial banks can borrow money from RBI, when they run short of reserves, is called 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.

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.