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Definition: Key Rate
The banks gain profits from lending the amount that they receive in the form of deposits. There might be a situation where the bank gives loans and the deposits are withdrawn too during the same period. Usually, banks have a minimum reserve requirement to be kept with them as a percentage of the deposits that the bank holds. In cases where the bank cannot maintain the minimum reserves, banks lend money from other banks or from the Central bank (i.e. RBI in India).
Key rate is defined as the rate at which banks are lent by other banks. This rate is used to regulate money supply in the country by the Central bank. Based on the monetary policy implemented, central bank increases or decreases the key rate. If there is an expansionary monetary policy in vogue, then the Central Bank decreases the key rate so that banks take more loans from the central bank and in turn lend more to the investors and households, thereby increasing the money supply in the market.
In case of a tight monetary policy, the key rate is increased so that banks take less loans and lend less to the public therefore, money supply in the market would be reduced.
In US, there are two key rates: 1. Discount rate 2. Fed Funds rate
The Federal Reserve Discount Rate is that rate at which Federal Bank lends to the other banks in case the banks do not meet their reserve requirements. In case, such a bank takes the loan from another bank, then the discount rate would be applicable. The Federal Bank usually changes the discount rate which in turn triggers a change in the Fed Funds rate.
These loans are usually for a short period of time and unsecure.