Bank rate is the rate at which the central bank gives loans to the commercial banks against the security of government and other approved first class securities. In modern times the central banks have armed with the weapon of bank rate which they employ for the purpose of credit control in the economy. By making appropriate changes in the bank rate, the central bank controls the volume of total credit indirectly by influencing the lending rates of commercial banks as a determinant of the total loans and investment in the country. This principle on which regulation of total credit should be based was stated in1802by Kenry Thornton in these words. In order to ascertain how far the desire of obtaining loans at the bank may be expected at any time to be carried, we must enquire into the subject of the quantum of profit likely to be derived from borrowing there under existing circumstances. This is to be judged of by considering two points , the amount, first of interest to be paid on the sum borrowed an secondly , on the mercantile or other gain to be obtained by the employment of borrowed capital we may therefore consider this question as turning principally on a comparison of the rate of interest taken at the bank with current rate of mercantile profit. Under its bank rate policy the central bank control credit by changing its bank rate. The central bank rediscounts the approved securities either directly or indirectly through money market and makes money available to the commercial banks. By raising the bank rate the central bank makes the obtaining of funds from the central bank costlier for the commercial banks the central bank may also refuse to rediscount certain bills it was hitherto rediscounting. In this way it makes credit scarce. Thus through the restricted and dear rediscount policy the central bank restricts credit creation by the commercial banks in the economy. similarly in depression when it is necessary to encourage the commercial banks to create more credit the central bank may discount approved securities of the commercial banks on liberal terms encouraging them to avail of the borrowing facility more frequently. This significance of central bank rate policy is three fold.
1.The bank rate indicates the rate at which the public should be able to obtain accommodation against the security of approved securities from the commercial bank.
2. The bank rate indicates the rate of interest at which the commercial banks can borrow funds from the central bank against the security of government and other approved securities.
3. The bank rate acts as a barometer of the economic situation in the country. If the central bank raises its bank rate, it is a danger single while a fall in the bank rate shows clear path. A rise in the bank rate can be compared to the amber coloured light of warning to robot system of finance and economics or as the danger signal of the red light warning for the business community of rocks ahead on the way in which they are engaged. On the contrary, a fall in the bank rate indicates the green light indicating that the coast is clear and the ship of commerce may proceed on the way with caution.