If the Central Bank increases its bank rate

Analyze the question: The bank rate (also called the Minimum Rediscount Rate or Monetary Policy Rate in Nigeria) is the rate at which the Central Bank lends to commercial banks. The question asks what happens when the CBN increases it.

Concept: The bank rate is a tool of monetary policy. Changing it affects the cost of borrowing across the whole economy:

• Increase in bank rate → tight (contractionary) monetary policy → money supply falls
• Decrease in bank rate → easy (expansionary) monetary policy → money supply rises

Step-by-step solution:

1. The CBN raises its bank rate.
2. It now costs commercial banks more to borrow from the CBN.
3. Commercial banks pass this cost on by raising their own lending rates (interest charges rise).
4. Higher interest rates discourage customers and businesses from borrowing.
5. Less borrowing means less credit creation, so the money supply in the economy may be reduced.

Checking the options:

• A. Many banks will shut down – Incorrect. Banks adjust their rates; they don't close because of a rate change.
• B. Customers will borrow more – Incorrect. Higher rates discourage borrowing, so customers borrow less.
• C. The supply of money may be reduced – Correct. Costlier credit reduces lending and so reduces money supply.
• D. Interest charges by banks will fall – Incorrect. Interest charges will rise, not fall.

Answer: C

Tip: Remember "Rate up, money down; rate down, money up." A higher bank rate is used to fight inflation because it reduces the money in circulation. A lower bank rate is used to stimulate the economy during a slump.