Effectiveness of Bank Rate Instrument in Pakistan

On January 15, 1959, bank rate was raised in Pakistan from itstraditional level of 3 per cent to 4 per cent. This paper examines theeffect of this rise of one percentage point in the bank rate on theborrowings of scheduled banks from the State Bank, their reserves, theirlending rates, the supply of their credit, and the allocation of theircredit among various sectors of the economy. This is done by comparingthe values of certain relevant variables primarily in the year beforethe bank-rate change (1958) and the year after the bank-rate change(1959). From this examination of a single experience in Pakistan, it isnot desired to prove that the bank rate would be effective orineffective in future. It would, however, be unwise to ignore this bitof historical evidence in the country. The assessment will certainlygive some idea of what to expect in future in comparable circumstances.A rise in bank rate may be effective in curtailing scheduled bank creditin two different ways. First, it may be an effective way of announcingto 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 ofinterest. Second, a higher bank rate would make it costlier forscheduled banks to borrow from the State Bank. Scheduled banks maymaintain relatively higher reserves after an increase in the bank ratebecause they know that in the event they have to borrow from the StateBank, it will be at a higher rate. However, bank rate would become apenalty rate only if the scheduled banks do not have excess reserves,need to borrow from the State Bank, and the bank rate exceeds the ratecharged by scheduled banks.