Pakistan Institute of Development Economics



Effectiveness of Bank Rate Instrument in Pakistan

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.

M. Umer Chapra

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