Sunday, 3 June 2018

Effect on stock market if RBI increase the bank rates...

First, bank rate is the rate at which central bank (in case of India, it is RBI) of a country provides re-financing facilities or provides loans to the commercial banks.

When bank rate is lowered, it is called 'cheap money policy'. Money supply in the economy is increased. Commercial banks now can borrow from the RBI at cheaper rates and can pass on this change to their customers through by providing loans at cheaper rate. Now, say if you want to get a home loan, your cost of getting that loan gets decreased. Generally, RBI lowers the bank rate during a period of recession/slowdown or sluggish economic activity. Reduced costs of loans, encourage companies/manufacturing units etc to borrow more for increasing production and consumers to spend more. Thus, economic activity in the country picks up.

When RBI increases bank rate, it is called 'dear money policy'. Money becomes costlier. RBI, does so, generally, during a period of inflation. Commercial banks are compelled to pay higher interest to the RBI which in turn prompts them to raise the interest rates on loans they offer to customers. The customers then are dissuaded in taking credit from banks, leading to a shortage of money in the economy and less liquidity. So, while on the one hand, inflation is under controlled as there is less money to spend, growth suffers as companies avoid taking loans at high rates, leading to a shortfall in production and expansion.

Changes in the bank rate also affect the stock markets which generally react positively to reduction in the bank rate. Stock markets rise up in the anticipation or in the event of bank rate decrease while they are bearish on bank rate increase, generally.

RBI uses bank rate to balance economic growth and inflation.

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