Effectiveness of Bank Rate Instrument in Pakistan

Abstract

On January 15, 1959, bank rate was raised in Pakistan from its
traditional level of 3 per cent to 4 per cent. This paper examines the
effect of this rise of one percentage point in the bank rate on the
borrowings of scheduled banks from the State Bank, their reserves, their
lending rates, the supply of their credit, and the allocation of their
credit among various sectors of the economy. This is done by comparing
the values of certain relevant variables primarily in the year before
the bank-rate change (1958) and the year after the bank-rate change
(1959). From this examination of a single experience in Pakistan, it is
not desired to prove that the bank rate would be effective or
ineffective in future. It would, however, be unwise to ignore this bit
of historical evidence in the country. The assessment will certainly
give some idea of what to expect in future in comparable circumstances.
A rise in bank rate may be effective in curtailing scheduled bank credit
in two different ways. First, it may be an effective way of announcing
to both the banks and the public the direction of State Bank policy.
Scheduled banks may become cautious as a result of this, and may,
therefore, refuse to lend as much as previously at a given rate of
interest. Second, a higher bank rate would make it costlier for
scheduled banks to borrow from the State Bank. Scheduled banks may
maintain relatively higher reserves after an increase in the bank rate
because they know that in the event they have to borrow from the State
Bank, it will be at a higher rate. However, bank rate would become a
penalty rate only if the scheduled banks do not have excess reserves,
need to borrow from the State Bank, and the bank rate exceeds the rate
charged by scheduled banks