BANK RATE - 15 Minutes Seminar Notes

 BANK RATE - 15 Minutes Seminar Notes

What Is a Bank Rate

• A bank rate is the interest rate at which a nation's central bank lends money to domestic banks, often in the form of very short-term loans. 
• Managing the bank rate is a method by which central banks affect economic activity. 
• Lower bank rates can help to expand the economy by lowering the cost of funds for borrowers, and higher bank rates help to reign in the economy when inflation is higher than desired.
  

How Bank Rates Work

• The bank rate in the United States is often referred to as the discount rate. 
• In the United States, the Board of Governors of the Federal Reserve System sets the discount rate as well as the reserve requirements for banks.
  
• The Federal Open Market Committee (FOMC) buys or sells Treasury securities to regulate the money supply. 
• Together, the discount rate, the value of Treasury bonds, and reserve requirements have a huge impact on the economy. 
• The management of the money supply in this way is referred to as monetary policy
  

Types of Bank Rates

Primary Credit

• Primary credit is issued to commercial banks with strong financial positions. There are no restrictions on what the loan can be used for, and the only requirement for borrowing funds is to confirm the amount needed and loan repayment terms.
  

Secondary Credit

• Secondary credit is issued to commercial banks that do not qualify for primary credit. 
• Because these institutions are not as sound, the rate is higher than the primary credit rate. 
• The Fed imposes restrictions on use and requires more documentation before issuing credit. 
• For instance, the reason for borrowing the funds and a summary of the bank's financial position are required, and loans are issued for a short-term, often overnight.
  

Seasonal Credit

• As the name suggests, seasonal credit is issued to banks that experience seasonal shifts in liquidity and reserves. 
• These banks must establish a seasonal qualification with their respective Reserve Bank and be able to show that these swings are recurring. 
• Unlike primary and secondary credit rates, seasonal rates are based on market rates.
  

POLICY RATES

• Policy Repo Rate  -  4.00%
  
• Reverse Repo Rate  -  3.35%
  
• Marginal Standing Facility Rate  -  4.25%
  
• Bank Rate  -  4.25%
  

How Does Repo Rate Work

• When you borrow money from the bank, the transaction attracts interest on the principal amount. 
• This is referred to as the cost of credit. 
• Similarly, banks also borrow money from RBI during a cash crunch on which they are required to pay interest to the Central Bank. 
• This interest rate is called the repo rate.
  

What are the Components of a Repo Transaction

Below are the parameters on the basis of which the RBI agrees to execute the transaction with the banks:

• Preventing Economy “squeezes”– The Central bank increases or decreases the Repo rate depending on the inflation. Thus, it aims at controlling the economy by keeping inflation in the limit.
  
• Hedging & Leveraging– RBI aims to hedge and leverage by buying securities and bonds from the banks and provide cash to them in return for the collateral deposited.
  
• Short-Term Borrowing – RBI lends money for a short period of time, maximum being an overnight post which the banks buy back their securities deposited at a predetermined price.
  
• Collaterals & Securities – RBI accepts collateral in the form of gold, bonds etc.
• Cash Reserve (or) Liquidity– Banks borrow money from RBI to maintain liquidity or cash reserve as a precautionary measure.

What is Meant by Reverse Repo Rate

• Reverse Repo Rate is a mechanism to absorb the liquidity in the market, thus restricting the borrowing power of investors.
  
• Reverse Repo Rate is when the RBI borrows money from banks when there is excess liquidity in the market. The banks benefit out of it by receiving interest for their holdings with the central bank.
  
• During high levels of inflation in the economy, the RBI increases the reverse repo. It encourages the banks to park more funds with the RBI to earn higher returns on excess funds. Banks are left with lesser funds to extend loans and borrowings to consumers.
  

Repo Rate    Reverse Repo Rate

• It is the rate at which RBI lends money to banks    It is the rate at which RBI borrows money from banks
  
• It is higher than the reverse repo rate    It is lower than the repo rate
  
• It is used to control inflation and deficiency of funds    It is used to manage cash-flow
  
• It involves the sale of securities which would be repurchased in future.    It involves the transfer of money from one account to another.
  

Presented By,

Gopinath

Banking Student 

Magme School Of Banking