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Bank Rate

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Under Section 49 of the Reserve Bank of India Act, 1934, the Bank Rate has been defined as "the standard rate at which the Reserve Bank is prepared to buy or re-discount[1] bills of exchange[2] or other commercial paper[3] eligible for purchase under the Act."

Bank rate is the rate at which central bank lends money to the commercial banks by buying their eligible rated securities - bills of exchange or commercial paper.

Bank Rate once used to be the policy rate (the key interest rate based on which all other short term interest rates move) in India. A rise in bank rate raises the deposit as well as lending rates in the economy while a lowering of the bank rate reduces these rates. It is the central banker’s tool for controlling liquidity and inflation.

On the introduction of Liquidity Adjustment Facility (LAF), discounting/rediscounting of bills of exchange by the Reserve Bank has been discontinued. As a result, the Bank Rate became dormant as an instrument of monetary management.

Bank Rate is now aligned to Marginal Standing Facility (MSF) rate, the penal rate at which banks can borrow money from the central bank over and above what is available to them through theLAF window. In other words, MSF assumed the role of bank rate, once the latter became operational in 2011.

Bank Rate is now used only for calculating penalty on default in the maintenance of cash reserve ratio (CRR) and the statutory liquidity ratio (SLR).

Since Bank rate has been aligned to the MSF rate, it changes automatically as and when the MSF rate changes, alongside policy repo rate changes. Accordingly, the penal interest rates levied on banks for not meeting their reserve requirements (which are specifically linked to the Bank Rate using a formula; i.e., Bank Rate +3 percentage points; Bank Rate +5 percentage points), also stand revised as and when the repo rate is revised.

Unlike other policy rates, the bank rate is purely a signalling rate and most interest rates are de-linked from the bank rate.

The current bank rate may be seen on the website of RBI. Historical rates may be seen from the RBI database.

1. While discounting a bill, the Bank buys the bill (i.e. Bill of Exchange or Promissory Note) before it is due and credits the value of the bill to the customer's account after a discount charge. The transaction is practically an advance against the security of the bill and the discount represents the interest on the advance from the date of purchase of the bill until it is due for payment. Rediscount is the act of discounting bills for a second time perhaps with the central bank to gain funds from the central bank.

2. BOE [also called DRAFT], is a short-term negotiable financial instrument. It is defined as an order in writing signed by the maker, (the seller of goods/creditor) directing another person (the buyer/debtor) to pay on demand or at a fixed future date a certain sum of money to a specified person or to the order of that person or to the bearer of the bill. The bill of exchange [BOE] originated as a method of settling accounts in international trade. It became popular because the seller or creditor could obtain immediate payment from a banker by presenting a bill of exchange signed by the buyer (who, in so doing, had accepted liability for payment on maturity). The banker would purchase the bill at a discount from its full amount because payment was due at a future date; BOE also functions as a credit instrument until its maturity.

3. Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. Corporates, primary dealers (PDs) and the all-India financial institutions (FIs) that have been permitted to raise short-term resources under the umbrella limit fixed by the Reserve Bank of India are eligible to issue CP. CP can be issued for maturities between a minimum of 7 days and a maximum up to one year from the date of issue.

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