Read the chain of events given below:
The RBI increases the Bank Rate → ________ → The reserves held by commercial banks fall → The money supply decreases.
Which of the following fills the blank?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Loans taken by commercial banks from the RBI become more expensive.
The bank rate is the rate at which the RBI lends to banks. Raising it makes borrowing from the RBI costlier, so banks hold fewer reserves.
Option (1) Loans taken by commercial banks from the RBI become more expensive. — Correct. This is the direct effect of a higher bank rate.
Option (2) The RBI sells government bonds to the public in the open market. — Incorrect. A bond sale also cuts reserves, but it is a separate tool, open market operations.
Option (3) The Cash Reserve Ratio that banks must keep is raised. — Incorrect. The CRR is another tool. It does not follow from the bank rate.
Option (4) The money multiplier falls, so the same reserves support fewer deposits. — Incorrect. The money multiplier is 1 / CRR. The bank rate does not enter it.
NCERT (2026-27): “3.4 Policy Tools to Control Money Supply … It should be evident by now that if the Central bank changes the reserve ratio, this would lead to changes in lending by the banks which, in turn, would impact the deposits and hence, the money supply. … Selling of a bond by RBI (to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply. … The RBI can influence money supply by changing the rate at which it gives loans to the commercial banks. This rate is called the Bank Rate in India. By increasing the bank rate, loans taken by commercial banks become more expensive; this reduces the reserves held by the commercial bank and hence decreases money supply. A fall in the bank rate can increase the money supply.” |