Question

Explain in detail how monetary policy influences banks’ lending behavior

Answer 1

Monterey policy are the major deciding factors for fixation of a bank lending rate by different banks.

Central Bank plays a major role in deciding the monetary policy. It has different tools to control the money flows in the system and it keeps on readjusting it accordingly to maintain the demand and supply in the economy.

If a central bank wants to curb the inflation , it will Limit the money supply increasing interest rates so banks will also have to passed upon the increased lending rates to the consumers and there would be less lending.

Central Bank can also increase the reserve requirements of the banks so Bank will have to maintain a very high level of reserves and simultaneously it will have less money to lend to people. These are measures adopted for curbing inflation.

Central Bank also sells security to banks as a part of open market operations so commercial banks are left with less of money and money flow is Lesser and it helps to curb inflation.

Central Bank similarly helps to stimulate demand by cutting Interest rates and commercial banks pass in the lesser rates to consumers to inflate the demand and counter a recessionary situation.

Central Bank purchases securities as a part of open market operations so bank are provided with more money to lend and central banks also liberalise the reserve requirements so that would help the commercial bank to go away with mure lending to inflate the demand.

So Central Bank monetary policy are key deciders of bank lending rates as they also tends to regulate the money supply in the overall economy.