Bank Rate is generally considered as the primary instrument of monetary control. However, with the
market-driven interest rate policy and advent of liquidity adjustment measures, its efficacy has been
questioned. In this article, an attempt has been made to articulate the relevance of Bank Rate vis-à-vis
other instruments of monetary influence.
Interest rate control is a prominent feature of government intervention in financial
markets. The structure of interest rate was influenced by the requirements of financing
budget deficits and making bank credit available to favor activities at concessional rates.
Prior to reforms, interest rate was not performing any significant allocative function on
the asset side of banks’ balance sheets and credit was mostly allocative by non-price means.
In the early 1970s, the writings of Mckinnon and Shaw challenged the conventional
wisdom of government intervention in the financial sector. They argued that financial
repression—high reserve requirements, interest rate controls and direction of credit to
favored sectors is harmful for resource mobilization and resource allocation. In line with
Mckinnon and Shaw’s (1973) arguments, the Narasimham Committee put forth
recommendations for the liberalization of financial sector in India. In accordance with the
recommendations of the committee, SLR and CRR have been gradually reduced from
38.5% in 1991 to the present level of 25%. Banks have been given the freedom to declare
their own Prime Lending Rates (PLR).
After the deregulation of interest rate, the Reserve Bank of India, has been influencing
the structure of interest rates through the variation in Bank Rate and modulating the
liquidity in the economy. The Bank Rate has been reduced from 11% to 6% in the last
five years. As a response to this measure, Banks have reduced their deposit rates across
the maturity but the lending rates have not come down commensurately with the
reduction in Bank Rate. Questions have been raised about the importance of Bank Rate
as an instrument of monetary policy with the emergence of repo/reverse repo. This article
attempts to analyze the role of Bank Rate in influencing the interest rates, and thus, the
real sector of the economy.
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