P.E.

SOCIETY’S

MODERN LAW COLLEGE

GANESHKHIND UNIVERSITY CIRCLE, PUNE

DEPARMENT OF LAW

2023-24

TOPIC

BANK RATE POLICY FORMULATON UNDER RBI

RESEARCH ARTICLE SUBMITTED BY

( MEHUL DHARMENDRA SHAH )

UNDER THE GUIDANCE OF

PROF. ADITI MISHRA

Bank Rate Policy Formulaton Under RBI

Abstract :

The RBI regularly controls the level of credit supplied by the commercial banks by changing
the bank rate. When Bank rates changes it suddenly impacts on Economy. When RBI
decrease bank rate it is called 'cheap money policy'. Money supply in the economy is
increased. When RBI increases bank rate, it is called 'dear money policy'. Money supply in
the economy is decreased. RBI uses bank rate to balance economic growth and inflation. This
paper examines Changing bank rates & its impact on Indian economy. This paper Researcher
has tried to find out extent changing bank rate facilitated impact on Indian economy.

Introduction :
Bank rate is the rate at which banks borrow money from the central bank without any sale of
securities. It is usually for a longer era of time. The RBI has the control to raise or decline
the bank rate. The RBI regularly controls the level of credit supplied by the commercial
banks by changing the bank rate. The commercial banks make loans by discounting bills of
exchange accessible to them by companies and merchants. Now if commercial banks do not
get sufficient deposit they move toward the RBI for funds and the central bank re-discounts
the bill of exchange detained by commercial banks. An increase in the bank rate by the RBI
implies that the commercial banks will have to pay higher interest rates while taking loans
from the RBI. They will, so, be required to charge higher rates of interest while making loans.
When the RBI increases the bank rate, the commercial banks are forced to pay higher interest
rates on the deposits they accept from the public. This also explicates why the commercial
banks charge higher rate of interest, while making loans and advances, when the bank rate
increases. There is, in reality, an involuntary relation between the bank rate & the market
rate. This means that as and when the bank rate increases the market rates of interest
automatically raise. The converse is also true. When the central bank decreases the bank rate
the commercial banks decrease their lending rates. This means that the market rates of
interest involuntarily fall. When the market rates of interest increase, firms and
consumers of durable goods will be less ready to take loans from banks than before &
business people finds it less money-making to borrow funds for investment purposes. The
banks are also less ready to make loans. It is because if they build more loans they have to
move toward the RBI for funds. And the RBI will charge higher rate of interest from
commercial banks for making loan. Therefore two things happen when the bank rate
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increases. First, the market rates of interest increases & the demand for bank loans
decrease & Secondly, commercial banks have to get funds from the central bank by paying
higher rates of interest. For both the reasons the commercial banks make less loans
when the bank rate increases. The converse is also true. The commercial banks make more
loans in the event of a fall in the bank rate. This explains why the bank rate is increased
during inflation and is decreased during deflation (recession).

Bank Rate Definition:

The Bank Rate meaning is the interest rate of financial institutes at which India’s central
bank, the Reserve Bank of India (RBI), provides loans to domestic or commercial banks
without collateral.

 The Reserve Bank of India determines the Bank Rate, which is declared at the
monetary policy review that is conducted bi-monthly.
 The bank rate is in accordance with the primary goal of meeting the inflation targets.
 The current bank rate as determined by the Reserve Bank of India is 6.75%.

Bank Rate Policy and Marginal Standing Facility (MSF) rate have a link, and when the MSF
rate changes, so does the Bank Rate. The Reserve Bank of India decides the Bank Rate. This
rate is slightly higher than Repo Rate. The bank rate meaning states that the interest rate
charged to the commercial and financial banks of India by the head of the financial institutes,
Reserve Bank of India.

The RBI, in its monetary policy review, determines the Bank Rate based on the entire
situation of the overall economy. The Reserve Bank of India lends large funds to commercial
banks at this rate.

The Reserve Bank of India is the main authority determining the bank rate, it is altered
frequently. Though, there is no prescribed or fixed schedule for the alteration of the Bank
Rate.

Types of Bank Rates in India :

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The Monetary Policy Committee (MPC) requires a mixture of different bank rate policies to
keep the Indian economy from slipping into the den of inflation. There are different types
of bank rates in India contributing to the MPC’s attempts. They are explained below.1

1. Repo Rate and Reverse Repo Rate

Bank rate and repo rate are similar terms and often confuse one another. The repo rate, an
abbreviation of Repurchase Agreement or Repurchasing Option, is the rate at which the RBI
provides commercial banks with loans against government securities. In this case, the banks
will purchase the securities from the RBI. The RBI attempts to propel the cash liquidity or
drain the excess by changing the repo rate. The current repo rate (dated January 7, 2023) is
6.25%. The reverse repo rate can be the reverse of the repo rate. It is the rate at which
commercial banks lend funds to the RBI. This instrument helps control inflation as the excess
of funds with commercial banks is borrowed by the RBI and returned with the charge as and
when the banks require. The current reverse repo rate (dated January 7, 2023) is 3.35%.2

2. Statutory Liquidity Ratio (SLR)

A commercial bank must retain a percentage of liquid cash, gold or other securities as
deposits. This is known as Statutory Liquid Ratio or SLR and is controlled by the RB. In
essence, it is the minimum amount of reserves that banks must have to extend credit to clients
and are held by the banks themselves, not the RBI. The convenient tool, SLR, is used by the
Monetary Policy Committee (MPC) to regulate inflation, credit expansion, and liquidity flow
and was established as per Section 24 (2A) of the Banking Regulation Act of 1949. The SLR
on January 7, 2023, is 18.00%. 3

3. Cash Reserve Ratio (CRR)

Cash Reserve Ratio (CRR) is a percentage of deposits required by commercial banks to be

maintained in the form of liquid cash with the RBI as reserves. Unlike SLR, banks do not
keep a balance with themselves. The CRR contributes to determining the base rate and is a
part of the RBI’s monetary policy. It is also a measure by the RBI to control the cash flow in
the Indian economy. The CRR as on January 7, 2023, is 4.50%.4
1
https://www.urbanmoney.com/banking/what-is-bank-rate
2
https://www.urbanmoney.com/banking/what-is-bank-rate
3
Abid
4
Abid

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 4. Marginal Standing Facility Rate (MSF)

Marginal Standing Facility (MSF) is a facility extended to commercial banks by the RBI in
the event of an emergency to obtain liquidity overnight. The option is available to the banks
of the inter-bank liquidity is dried up. Under the Liquidity Adjustment Facility or LAF, banks
borrow from the RBI by pledging government securities at a rate higher than the repo rate.
The MSF rate is set at 100 basis points, or one percentage point, above the repo rate. Under
MSF, banks can borrow up to 1% of their Net Demand and Time Liabilities (NDTL). The
MSF rate as on January 7, 2023, is 6.50%.5

5. Lorenz Curve

A Lorenz curve is a graphical representation of income or wealth inequality developed by

American economist Max Lorenz in 1905. The graph depicts population percentiles based on
income or wealth on the horizontal axis and cumulative income or wealth on the vertical
axis.6

6. Non-Performing Assets (NPAs)

A non-performing asset (NPA) is a loan or advance on which the principal or interest

payment has been late for 90 days. Banks are required to categorise NPAs further as the
following.

 Substandard Assets: Assets that have been NPA for less than or equal to 12 months.

 Doubtful Assets: An asset is questionable if it has been in the substandard category for 12
months.

 Loss Assets: According to the RBI, a loss asset is considered uncollectible and of such low
value that its continued existence as a bankable asset is not warranted, even if there may be
some salvage or recovery value.7

Traditional Approach and Todays Approach:

1. Traditional approach: -

5
https://www.urbanmoney.com/banking/what-is-bank-rate
6
Abid
7
Abid

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 Bank rate means on which central bank discounts and rediscount the eligible bills.

2. Today's approach: -

Bank rate means the minimum rate on which central bank provides financial accommodation
to commercial bank in the discharge of its function as the lender of the last resort.

Determination of Bank Rate

Section 49 of the Reserve Bank Of India Act 1934 determines and regulates the Bank rates.

 The Reserve Bank of India (RBI) is the authority in India to determine the Bank Rate.
 The RBI in its bi-monthly monetary policy review announces the bank rate based on
the macroeconomic situation.
 The Bank Rate is announced keeping in mind the primary goal of inflation targeting.
 If the Bank rate is decreased then it increases the money supply in the economy as the
banks borrow and lend it to customers. On the other hand, if the Bank rate is increased
it will inhibit the money supply in the economy.8

As of February 2023, the latest Bank Rate from RBI is 6.75%. The RBI determines this rate
and other rates such as Repo Rate and Reverse Repo Rate. The current Repo Rate is 6.50%,
and the Reverse Repo Rate is 3.35%. These rates may change due to changes in the MSF rate
and prevailing economy from time to time. Section 49 of the Reserve Bank Of India Act
1934 regulates and determines the Bank Rate. The Reserve Bank Of India executes the
monetary policy review bi-monthly in which the bank rate is declared by the officials
depending on the macroeconomic situation of the country.

Factors while determining Bank Rate in India

The Reserve Bank of India (RBI) takes into consideration several factors when determining
the Bank Rate. These factors include:

1. Inflation
The RBI assesses the prevailing inflation rate and its outlook. Higher inflation may
prompt the RBI to raise the Bank Rate to curb inflationary pressures.
2. Economic Growth

8
https://prepp.in/news/e-492-bank-rate-indian-economy-notes

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 The RBI considers the state of economic growth and overall macroeconomic
conditions. The Bank Rate may be adjusted to stimulate or moderate economic
activity based on growth objectives.
3. Monetary Policy Objectives
The RBI aligns the Bank Rate with its monetary policy objectives, which include
price stability, growth, and financial stability. The rate is set to achieve these
objectives effectively.
4. Market Conditions
The RBI analyses market conditions, including interest rate levels, credit demand,
liquidity, and investor sentiment. These factors influence the decision on adjusting the
Bank Rate. The frequency of changes to the Bank Rate depends on the prevailing
economic conditions and monetary policy stance. The RBI may choose to change the
Bank Rate during its periodic monetary policy review meetings, typically held every
two months. However, the RBI can also make off-cycle changes if there is a need to
address emerging economic challenges or maintain policy effectiveness. The timing
and frequency of Bank Rate changes are determined by the RBI based on its
assessment of the economic situation and policy requirements.
Impact Of Bank Rate :
The Bank Rate policy depends on the MSF rate, and when the Reserve Bank of India
increases the Bank Rate, the commercial bank borrows the funds at a higher price and
reduces the credit volume. When the Bank Rate rises, banks experience a decline in
the money supply. The Bank Rate is determined keeping into consideration the
primary goals of attaining the inflation targets. If the bank rate is reduced then the
economic flow in the country increases, on the other hand, if the bank rate surges the
economic flow in the country decreases.
Bank Rate Vs Repo Rate :
The significant difference between the Bank Rate and Repo Rate is that the Bank rate
directly impacts customers since it impacts long-term funds lending. In contrast, Repo
Rate doesn’t impact the customer directly.
The Reserve Bank Of India applies Repo Rate to the repurchase of securities sold by
commercial banks and the Bank Rate to loans that the RBI gives to commercial
banks.
The Repo Rate is lower than the Bank Rate due to the collateral and repurchase
obligation. The Reserve Bank of India provides Repo Rates on short-term financial
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 lending to banks while Bank Rates issues to long-term requirements of domestic
banks.

Bank Rate vs. Overnight Rate

The discount rate, or bank rate, is sometimes confused with the overnight rate. While the
bank rate refers to the rate the central bank charges banks to borrow funds, the overnight rate
—also referred to as the federal funds rate—refers to the rate banks charge each other when
they borrow funds among themselves. Banks borrow money from each other to cover
deficiencies in their reserves.

Banks are required to have a certain percentage of their deposits on hand as reserves. If they
don't have enough cash at the end of the day to satisfy their reserve requirements, they
borrow it from another bank at an overnight rate. If the discount rate falls below the overnight
rate, banks typically turn to the central bank, rather than each other, to borrow funds. As a
result, the discount rate has the potential to push the overnight rate up or down.

As the bank rate has such a strong effect on the overnight rate, it also affects consumer
lending rates. Banks charge their best, most creditworthy customers a rate that is very close to
the overnight rate, and they charge their other customers a rate that is a bit higher.

For example, if the bank rate is 0.75%, banks are likely to charge their customers relatively
low-interest rates. In contrast, if the discount rate is 12% or a similarly high rate, banks are
going to charge borrowers comparatively higher interest rates.9

How to Calculate Bank Rates?

The central financial authority of the nation charges an interest rate that is directly related to
the money supply of the entire economy. Hence, the Reserve Bank of India (RBI) controls
and determines the bank rate in India. The RBI has several tools to regulate the supply of
money and credit in the economy, including the repo rate, reverse repo rate, and the Cash
Reserve Ratio (CRR).

Furthermore, when there is a change in the bank rate, there is a significant influence on the
entire economy. For instance, the stock market prices can change when fluctuations in the

9
https://www.investopedia.com/terms/b/bankrate.asp

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bank rate occur. Moreover, these changes in interest rates also affect the customers who
borrow loans from financial institutions.

Bank Rate Policy :

The Bank rate policy denotes the policy by which the Reserve Bank of India (RBI), the
country’s central bank, regulates the supply of money and credit in the economy. As you
know, the bank rate is the rate of interest at which banks borrow funds from the RBI. Hence,
changes in this interest rate not only affect the banks but also the rest of the economy.

Furthermore, the Reserve Bank of India has the power to increase or decrease the supply of
money in the country. When they wish to increase the money supply, RBI decreases the bank
rate. On the contrary, to decrease the money supply in the economy, RBI increases the rate of
interest for banks. Therefore, we can conclude that the bank rate policy is one of the key
monetary tools used by the central financial institution of India to achieve its economic goals.

How does the RBI use its bank rate?

The RBI uses its bank rate to set the minimum amount a bank must pay its customers who
park money with it. Banks use these funds to make loans and other investment opportunities
for themselves and their clients; in practice, the bank rate directly impacts the loan rate
offered by banks (to businesses and consumers). As is usually the case when regulators alter
rates to change monetary policy, lowering the bank rate helps stimulate spending in a given
economy as lower interest rates mean borrowing money becomes more affordable for
everyone from individuals to small businesses. Raising rates has an opposite effect—it makes
lending money more expensive, which tends to slow economic activity and can lead to
unemployment.

Movements in Bank Rate during 2013-2023

1) 2013 :
Over 6 per cent points decline in inflation since late 2013.
2) 2014 :
Strategic headed for added moderation command be there facts to authenticate
abiding disinflationary pressures. Besides analytical would be there sustained
prohibitive class financial consolidation 23 satisfactorily in the role of steps

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 toward overcome resource constraints in addition to promise availability of
major inputs such for example power, land, natural resources plus
infrastructure.
3) 2015 :
The Bank Rate stands adjusted by 50 basis points from 8.25 per cent to 7.75
per cent captivating benefit of reduction inflation to increase growth in an
economy that hasn't been able to getaway global headwinds. The Bank Rate
stands adjusted by 25 basis points from 8.5 per cent to 8.25 per cent with
effect from June 2, 2015.Corporate earnings boast been depressing; growth
happening bank lending has been the insignificant here about two decades.
The Bank Rate stands adjusted by 25 basis points from 8.75 per cent to 8.5 per
cent with effect from March 4; 2015.Government has certainly paid
consideration to the quality of fiscal adjustment. Aggressive rate cuts are not
promising participating in this time for the reason that they obtain by now
signed the Memorandum of Understanding along with the RBI going on
supple inflation targeting. Furthermore, inflation is on the midpoint level. The
Bank Rate stands adjusted by 25 basis points from 9.0 per cent to 8.75 per
cent with effect from January 15, 2015.The fifth bi-monthly monetary
policy statement moreover confirmed to facilitate a long time ago the
pecuniary strategy stance shifts, succeeding guidelines procedures
determination stay uniform plus this stance. Type near auxiliary respite is
statistics with the purpose of make firmer ongoing disinflationary pressures.
and unsympathetic would be present sustained lofty condition financial
consolidation in the same way as positively being steps in the direction of
overcome fund constraints along with reassure availability of key in inputs
such while power, land, mineral deposits after that infrastructure. The final
would transpire wanted on the road to make sure with the aim of probable
yield rises more than the projected pick-up in vogue lump participating in
introduction quarters accordingly since toward have inflation.

4) 2016 :
DR. URJIT R. PATEL maiden policy of announcement facilitates RBI
Governor. This was the Central bank's fourth bi-monthly document
statement during give preferentiality of the while 2016-17. In its policy
x
 statement, the inner earlier believed so as to the verdict of the fiscal
guidelines board was unfailing among the accommodative stance of the
pecuniary policy. Retail inflation is estimated toward transpire 5 apiece cent

before strut 2017 along with upside risk.

5) 2017 :
As announced in the Third Bi-Monthly Monetary Policy Statement 2017-18
dated August 02, 2017, the Bank Rate stands adjusted by 25 basis points from
6.50 per cent to 6.25 per cent with effect from August 02, 2017.10
6) 2018 :
As announced in the Third Bi-Monthly Monetary Policy Statement 2018-19
dated August 1, 2018, the Bank Rate stands adjusted by 25 basis points from
6.50 per cent to 6.75 per cent with immediate effect.11
7) 2019 :
As announced in the First Bi-Monthly Monetary Policy Statement 2019-20 of
April 04, 2019, the Bank Rate is revised downwards by 25 basis points from
6.50 per cent to 6.25 per cent with immediate effect.12
8) 2020 :
Accordingly, the marginal standing facility (MSF) rate and the Bank Rate
stand reduced to 4.25 per cent from 4.65 per cent. Since the MPC met in
March 2020, global economic activity has remained in standstill under
COVID-19 related lockdowns and social distancing. Among the key advanced
economies (AEs), economic activity contracted in the US, Euro area, Japan
and the UK in Q1:2020. Among emerging market economies (EMEs), the
Chinese economy went into a pronounced decline and data on high frequency
indicators suggest that activity may have also shrunk in other EMEs such as
Brazil and South Africa.13
9) 2021 :

10
circular DBR.No.Ret.BC.58/12.01.001/2016-17 dated April 06, 2017
11
circular DBR.No.Ret.BC.107/12.01.001/2017-18
12
RBI/2018-19/162 DBR.No.Ret.BC.33/12.01.001/2018-19
13
Reserve Bank of India https://m.rbi.org.in › scripts › BS_P...Press Release

xi
 Due to COVID19 era the marginal standing facility (MSF) rate and the bank
rate remain unchanged at 4.25 per cent.14

10) 2022 :
As announced in the Monetary Policy Statement 2022-23 dated December 07,
2022, the Bank Rate is revised upwards by 35 basis points from 6.15 per cent
to 6.50 per cent with immediate effect.15

11) 2023 :
As of February 2023, the latest Bank Rate from RBI is 6.75%.16

Conclusion :

The bank rate can be compared to a quarterback charging at inflation. Banks seek loans from
the RBI to maintain liquidity and meet reserve requirements. In response to the global crisis,
many central banks altered their interest rates to stimulate and stabilise the economy. We
hope you understand the economic term- bank rate.

bank rate is the interest rate charged by a country's central bank to financial institutions when
they borrow money. To meet reserve requirements and preserve liquidity, banks turn to the
central bank for loans. The interest rates charged by central banks are designed to keep the
economy stable.

Bank rate is a weapon of the monetary authority and playing the role of a reference rate. The
bank rate is a powerful tool for central banks because it can have a significant impact on the
economy. By changing the cost of borrowing money, central banks can influence spending,
investment, and inflation. This, in turn, can help to maintain economic stability and promote
growth.

References :

1. Reserve Bank of India https://m.rbi.org.in › scripts › BS_P...Press Release

2. Governor's Statement, June 4, 2021 - Reserve Bank of India
3. DOR.RET.REC.70/12.01.001/2022-23 dated September 30, 2022
4. Reserve Bank of India https://www.rbi.org.in › scripts › BS... Press Release

14
Governor's Statement, June 4, 2021 - Reserve Bank of India
15
DOR.RET.REC.70/12.01.001/2022-23 dated September 30, 2022
16
Reserve Bank of India https://www.rbi.org.in › scripts › BS... Press Release

xii
5. circular DBR.No.Ret.BC.58/12.01.001/2016-17 dated April 06, 2017
6. circular DBR.No.Ret.BC.107/12.01.001/2017-18
7. RBI/2018-19/162 DBR.No.Ret.BC.33/12.01.001/2018-19

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