Question

Consider the following steps taken by the Reserve Bank of India with respect to money supply and arrange them in the correct sequence: A. Increase in lending rates by commercial banks
B. Contraction in credit
C. Increase in bank rate by the Reserve Bank of India
D. Increase in cost of borrowings for commercial banks

• A. A, B, C, D
• B. A, C, B, D
• C. C, D, A, B
• D. C, B, D, A

Hint:

When RBI increases bank rate: \[ \text{Bank rate rises} \rightarrow \text{Bank borrowing cost rises} \rightarrow \text{Lending rates rise} \rightarrow \text{Credit contracts} \]

Answer 1

The Correct Option is C

Concept:
Bank rate is the rate at which the Reserve Bank of India lends money to commercial banks. When the RBI increases the bank rate, borrowing from the RBI becomes costlier for commercial banks. As a result, commercial banks increase their lending rates, which reduces demand for loans and causes contraction in credit.
Step 1: First action is taken by RBI.
The process begins when the Reserve Bank of India increases the bank rate. So, the first step is: \[ C = \text{Increase in bank rate by the Reserve Bank of India} \]
Step 2: Effect on commercial banks.
When the bank rate increases, borrowing from the RBI becomes expensive for commercial banks. So, the second step is: \[ D = \text{Increase in cost of borrowings for commercial banks} \]
Step 3: Commercial banks increase lending rates.
Since borrowing cost increases for commercial banks, they pass this cost to borrowers by increasing lending rates. So, the third step is: \[ A = \text{Increase in lending rates by commercial banks} \]
Step 4: Final effect on credit.
Higher lending rates make loans costlier. Therefore, people and firms borrow less, leading to contraction in credit. So, the fourth step is: \[ B = \text{Contraction in credit} \]
Step 5: Final sequence.
The correct sequence is: \[ C \rightarrow D \rightarrow A \rightarrow B \] Hence: \[ \boxed{\text{(C) C, D, A, B}} \]