Monetary Policy-Interest Rate Related Tools

In the previous chapter, we took a look at the liquidity-rated tools of monetary policy. In this chapter, let's now get to know about interest rate related tools of monetary policies.

1. Bank Rate

It refers to the rate at which the RBI lends money to commercial banks. It relates to the instant loan requirement of commercial banks. An increase or decrease in the bank rate is often followed by an increase or decrease in the market rate of interest, which is the interest rate charged by commercial banks to the general public.

The current bank rate (as of 30th July 2024) fixed by RBI is 6.75%.

Impact of increase and decrease of bank rate in an economy:

To control inflation in an economy, RBI will increase the bank rate, which will lead to an increase in the market rate of interest of credit, leading to a decrease in demand for credit, further leads to a decrease in money supply in an economy. Thus, inflation is controlled.

To control deflation in an economy, the RBI will decrease bank rates, which will lead to a decrease in the market rate of interest of credit. This will increase demand for credit and, further, the money supply in an economy. Thus, deflation is controlled.

2. Repo Rate

It is the rate at which the Central Bank - RBI offers short-period loans to commercial banks by buying government securities in the open market. In fact, it is a repurchase rate where a repurchase agreement is signed by both parties stating that the commercial banks will repurchase the securities on a given date at a predetermined price.

The current repo rate (as of 30th July 2024) fixed by RBI is 6.50%.

Impact of increase and decrease of bank rate in an economy:

To control inflation in an economy, RBI will increase the repo rate, which will lead to a decrease in demand for credit, further leads to a decrease in money supply by the commercial banks in an economy. Thus, inflation is controlled.

To control deflation in an economy, the RBI decreases the repo rate, which leads to an increase in demand for credit and, further, an increase in the money supply by the commercial banks in an economy. Thus, deflation is controlled.

3. Reverse Repo Rate

It is the rate at which the RBI accepts deposits from commercial banks through government securities. It is also called reverse repurchase rate. In this case, both parties stating that the securities will be repurchased on a given date at a predetermined price sign a reverse repurchase agreement.

The current reverse repo rate(as of 30th July 2024) fixed by RBI is 3.35%.

Impact of increase and decrease of bank rate in an economy:

When the reverse repo rate is lowered, banks are discouraged from parking their surplus funds with the RBI. This leads to more funds being parked by commercial banks as CRR funds with RBI for the creation of credit, which increases the money supply in the economy. Thus, deflation is controlled.

When the reverse repo rate is increased, banks are encouraged to park their surplus funds with the RBI, which leads to fewer funds parked by commercial banks as CRR funds with RBI for the creation of credit, which decreases the money supply in the economy. Thus, inflation is controlled.

4. Marginal Standing Facility Rate

The Marginal Standing Facility (MSF) is a penal rate at which banks can borrow money from the Reserve Bank of India (RBI) in an emergency when they have exhausted all other borrowing options. It allows banks to borrow money at an interest rate higher than the repo rate.