The General Instruments
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These instruments are called general because they are uniformly applicable to all commercial banks and in respect of loans given for all purposes. The general instruments are as follows:
The Bank rate policy: Bank rate is the official rate at which the central bank of the country rediscounts bills offered by the commercial banks. The following example shows how a change in the bank rate can bring about a change in the supply of money.
A Bill is drawn when some goods are sold by a person to another person. A Bill is an order made by the drawer (the seller) on the drawee (buyer) to pay a particular amount of money to him (the seller) on or before a particular date. The bill is accepted by the drawee and then it becomes a negotiable instrument. It is returned to the drawer. He can discount that bill with a commercial bank. The rate at which the bill is discounted by the commercial bank is called the Market Rate. If the bank is itself in need of money it rediscounts the same bill with the Central bank of the country. The rate at which the bill is rediscounted by the central bank is called the Bank Rate. It is normally a little below the market rate. The difference between the MR and BR gives profit margin to the commercial bank.
When the central bank wants to bring about a contraction in bank credit, it raises the bank rate. The effect is that the commercial banks raise the market rate in order to retain their profit margin. Rise in the market rate brings about a contraction in the volume of bills offered by the customers to the commercial banks. If the volume of bills is less, the amount of money going out from the commercial banks to the people is less i.e.: the supply of money is less.
If the central bank wants to bring about an expansion of Bank credit it lowers the bank rate. The commercial banks can lower the market rate due to which the people offer more bills for discounting and the supply of money increases.
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