In this lesson, we will discuss one of the important monetary instruments of the Reserve Bank of India. You will be able to learn the following terms by the end of this lesson.
“The Bank Rate is the rate of interest at which commercial banks and other financial institutions borrow money for long term period from the central bank of the country (Reserve Bank of India) without repurchase agreement of securities or without keeping government securities as collateral.”
In other words, if the commercial banks or other financial institutions require to arrange funds for more than 90 days, they’ll have to approach to the Reserve Bank of India, the central bank of India, for getting the loan approved.
Thus the rate of interest at which the RBI lends the funds to the commercial banks or other financial institutions is called as the Bank Rate. However, there is not any repurchase agreement of the government securities or collateralised securities between RBI and banks.
How Bank Rates are used by RBI?
Used as a Penal Rate:
The bank rate majorly uses as a penal rate by the RBI. This means it is a reference rate to impose a penalty on the commercial banks or other financial institutions in case of any default of the monetary policy of the central bank of a country.
Example: If the commercial banks fail to maintain the SLR (Statutory Liquidity Ratio) or CRR (Cash Reserve Ratio), the rate of penalty are:
- On the first day – Bank Rate + 3%
- On succeeding working day – Bank Rate + 5%
Discounting of Bill of Exchange and Commercial Papers:
The bank rate is often used to re-discount the bill of exchange and commercial papers of commercial banks. Thus it is said that the Bill of Exchange and commercial papers are rediscounted on the Bank Rate by the RBI.
Difference between Bank Rate and Repo Rate:
Although the Bank rate and Repo rate are the instruments of RBI to control the supply of money and inflation rate, yet there are some differences between both which are:
- At Bank rate, commercial banks borrow funds for more than 90 days, on the other hand, at Repo rate banks borrowers money for less than 90 days. In other words, on Bank Rate commercial banks fulfil their long term requirements of funds, whereas, at Repo Rate, banks fulfil their short term needs of money.
- To borrow loan at Repo rate banks has to sign a repurchase agreement of collateralised securities whereas, in case of bank rate, commercial banks don’t need to keep the RBI approved securities as collateral.
- Bank rate is always higher than the Repo rate.
- Bank rates are majorly used to discount commercial papers and Bill of exchange and also used as penal rate whereas Repo rate is a liquidity adjustment facility and exclusively used for short term loans to the commercial banks.
- A rise in Bank rate directly affects the customers directly whereas, in case of Repo rate, being a concern between bank and RBI, it doesn’t affect lending rate directly.
Conclusion:
Hope you have understood the meaning and definition of bank rate. In a nutshell, a bank rate is implemented to the banks or financial institution for the long-term advances. Also, the bank rate is utilised by the commercial banks as a penal rate and for the purpose of re-discount the bills of exchange and commercial papers.
Related Terms:
