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What is the Discount Rate
All the banks whether Nationalized or Private have to borrow and lend money. This is available at different rates. This is how any bank operates.
In India Reserve Bank of India is at the apex. RBI decides the rates which should be applicable to all kinds of banks. One of these rates is the Discount rate.
The discount rate is the rate at which the banks can borrow money from the Federal Reserve Bank. In India it is RBI. It is the RBI that decides the rate and also controls all the nationalized banks. RBI also controls the money supply and money demanded in the economy.
There are some special privileges that some banks are eligible for simply because they might be member banks.
How Discount Rate is considered very important
The discount rate is so important because it helps in deciding the cash flow of the bank. The discount rate helps to find out the net present value of the institution and thus it has a high computation value.
However, the important point to remember is that the discount rate is applicable only to short-term finance and not long-term borrowings. Thus when discount rates are termed it should be remembered that the institutions are indulged in short-term borrowings.
If we want to calculate Discount rates then let’s take an example. Suppose the government plans to sell some of its bonds at Rs. 95 and at the year-end the government is planning to pay Rs. 100 then the calculation of the discount rate is:
100 – 95/100 = 5%.
The Discount Rate is 5%.
The discount rate helps the bank in many ways because the Discount rate helps the bank to finance short-term liabilities.
It helps the bank to buy short-term assets as well.
Thus Discount rate is a helpful way by which banks can borrow short-term finance from the apex federal bank and can support their cash flow.
This is how an efficient and proper Discount Rate flows in the economy and it is the duty of the federal bank to have a look at the amount of money that flows into the economy.
It should know when to increase the rates and decrease the same. This is how the entire system of Discount rate works.
Discount Rate Homework Help