Bank rate – definition and meaning

The bank rate, also known as the base rate, discount rate or the federal discount rate in the US, is the interest rate charged by a central bank on loans and advances to domestic banks. Banks across a nation base their interest rates on the bank rate.

Whenever a bank is short of funds, it will borrow from the central bank. This is typically done via repos, where the repo is the rate at which short-term money is lent by the central bank to commercial banks against securities.

When the repo rate declines, banks are able to get money at a cheaper rate. When it goes up, borrowing from the central bank becomes dearer.

Bank Rate
The bank rate decides what our mortgage and personal loan rates are.

The reverse repo rate is the rate at which banks can place excess funds with the reserve bank.

Central banks require that their domestic banks maintain a certain percentage of their desposits in cash, known as the reserve requirement. When a bank cannot meet the reserve requirement, it may borrow from other banks or the central bank.

These central bank loans are usually for very short periods, typically overnight.

Bank rate used to regulate the economy

Banks can regulate the level of economic activity in a country by managing the bank rate. The rate is lowered when the central bank wants to boost the economy. This may be when unemployment is high, company closures are increasing, and investment and borrowing levels are low.

On the other hand, when there are signs the economy is overheating and needs to be slowed down, or when inflation is getting too high, the rate will be raised.

Banks are discouraged from borrowing to meet reserve requirements when the bank rate is high. This causes them to build up reserves, and thus make fewer loans. When the rate falls the effect is the opposite – banks make more money available for lending.

The term ‘bank rate’ might also refer to the rates commercial banks charge their customers on loans.

Video – What is the discount rate