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Indian Financial System

Notes of credit is influenced by appropriate changes in the conditions under which the Central Bank
provides credit to commercial banks such as difficult access or easy access. Thus, rising of the
bank rate makes credit dearer through more or less equivalent changes in the commercial banks
interest rate and in the market rate of interest rate and vice versa. Thus, the bank rate policy has
the following effects:

1. Commercial banks find it difficult or easy to approach the Central Bank for loans, which
limits or increases their ability to create credit respectively.
2. Commercial banks are expected to raise their rate of interest or reduce it. This affects the
market rates of interest accordingly. The credit either becomes dearer or cheaper as the
case may be. Accordingly, there are anti expansionary or pro expansionary effects on
credit creation.
Interest Rate Policy in India

The RBI has been operating the interest rate policy in a flexible manner in tune with the development
requirements of the economy. The bank rate is their standard rates of discount or advance to both
banks and financial institutions. It provides refinance to banks varying rates, depending upon the
purpose and security under section 17 of the RBI Act. Although the bank rate is its standard rate, it
is not applicable to all lending by the RBI. Similarly, bank's borrowing and lending rates have
been fixed by the RBI with in a broad spectrum, from a low rate of 4% for DRI loans to weaker
section to a maximum lending rate of 17% for general purposes. There are multiplicities of rates to
suit the needs of sectarian developments and to meet the socio economic obligations of the
government. Some rationalization of these rates is also attempted to the RBI in tune with the
recommendations of the Chakravarthy Committee referred to later. The discount and rediscounts
rates on bills, government borrowing rates, etc. have been revised recently to bring them in line
with the more realistic market oriented rates. The bank rate fixed by the RBI in 1990 to 91 was 10%
per annum and has since been brought down by stages to 6% p.a. by 2004 to 2005.

Refinance Rates

There are many rates of refinance charged by the RBI for the financial accommodation to banks,
depending up on the purpose and/or security. While the standard lending rate is the bank rate,
there are special rates or refinance rates for lending against export bills or against banks food
credits. There are also other rates for stand by refinance and discretionary refinance provided by
the RBI. The net effective rate of refinance provided by the RBI is, therefore, different from the
bank rate. The Repo rate is the prevailing rate of RBI by which it controls the call money and
short-term rates, and Repo deals are referred to later.
Importance of Bank Rate

Bank rate is the leader among interest rates and sets the pace for other rates. Any change in it
indicates a change in the Central Bank policy. Bank rate and changes in interest rates or the
major instruments of monetary policy, which are activated in India since 1996, are now operated
in a flexible manner.
In India, due to the needs of cheap Government finance and developmental needs of the economy,
bank rate changes have been kept to the minimum, while other refinance rates have been
changed, depending on the requirements of the economy.

Impact of Bank Rate Policy

Bank rate influences the economy both on the domestic and external fronts. On the domestic
front, changes in bank rate affect investment and income in the economy through corresponding

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