REDISCOUNT RATE Meaning and
Definition
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The rediscount rate refers to the interest rate at which commercial banks can borrow funds from the central bank by rediscounting their eligible short-term loans or bills. It is the rate charged by the central bank when it acts as a lender of last resort to commercial banks. The purpose of setting a rediscount rate is to encourage liquidity in the banking system and provide a safety net for banks facing temporary cash flow issues.
When a commercial bank needs immediate funds, it can approach the central bank with eligible collateral in the form of loans or bills. The central bank evaluates the creditworthiness of the collateral and offers the funds at the predetermined rediscount rate, which may be lower than market interest rates. This enables the bank to meet its short-term obligations while maintaining liquidity.
The rediscount rate serves as a monetary policy tool for the central bank. By lowering the rediscount rate, the central bank encourages banks to borrow more, stimulating economic activity by increasing the money supply in circulation. Conversely, raising the rediscount rate makes borrowing more expensive and restricts liquidity, thereby curbing inflationary pressures.
The rediscount rate is an important indicator of the prevailing monetary conditions and the tightness of credit in a country's financial system. It influences rates for other short-term lending, such as interbank rates, which impact overall interest rates charged on loans and advances. Central banks may adjust the rediscount rate periodically to manage economic stability and control inflation, balancing the needs of the banking sector with macroeconomic objectives.
Etymology of REDISCOUNT RATE
The term "rediscount rate" is composed of two main components: "re-" and "discount rate".
1. "Re-" is a prefix derived from Latin meaning "again" or "back". In the context of "rediscount", it indicates the repetition or revisiting of a discounting process.
2. "Discount rate" refers to the rate at which a central bank, such as the Federal Reserve in the United States, lends money to commercial banks. It is the interest rate at which banks can borrow funds from the central bank using their eligible securities as collateral.
Therefore, the etymology of the term "rediscount rate" is the combination of the prefix "re-" indicating a repetition or revisiting, and "discount rate" referring to the interest rate at which central banks lend money to commercial banks.
