The percentage by which the money the borrower pays back exceeds the money that was borrowed is called as
- (a)Bank rate
- (b)Nominal interest rate
- (c)Real interest rate
- (d)Terms of credit
Correct — B, Nominal interest rate. The stem measures the excess of repayment over principal in money terms — rupees back against rupees lent — and that is exactly what the nominal rate is. It is the rate written into the loan agreement and the one the borrower actually hands over. The word 'nominal' is doing precise work here: it means counted in money, without any correction for what has happened to prices. Borrow Rs 100 and repay Rs 110 and the nominal rate is ten per cent, whatever inflation was that year. The real rate is what is left after that correction, and it is not what the stem describes.
- (a)Bank rate — One specific policy rate, not the general concept. The Reserve Bank Act defines the bank rate as the standard rate at which the central bank is prepared to buy or re-discount eligible bills of exchange and commercial paper. It is a rate the central bank offers to banks, not the percentage by which any borrower's repayment exceeds the sum borrowed.
- (c)Real interest rate — The nominal rate minus inflation, so it measures the extra purchasing power the lender gains rather than the extra rupees. With ten per cent charged and six per cent inflation the borrower still repays ten per cent more money, but the real rate is only about four per cent — and in a high-inflation year the real rate can be negative while money repaid still exceeds money borrowed.
- (d)Terms of credit — The whole package rather than one number. Interest rate, collateral, documentation requirement and mode of repayment together comprise what is called the terms of credit, and those vary from one credit arrangement to another. The interest rate is a term of credit; it is not the terms of credit.
Interest is the price of credit, quoted as a percentage of the principal for a stated period. The nominal rate counts that price in money. Since money loses purchasing power when prices rise, lenders and borrowers care about the real rate, which subtracts expected inflation from the nominal rate — the Fisher relation. Policy rates such as the repo rate and the bank rate are the central bank's own nominal rates, and they influence but do not equal the rate a household or firm finally pays.
Two of the options are true statements about interest that simply answer a different question, which is what makes the item worth slowing down for. Read the stem for what is being compared: money repaid against money borrowed, with no mention of prices, so no inflation correction is being made. That fixes the answer at nominal. The classic trap is to reach for 'real' because it sounds more rigorous. Anchoring to the exam, the gap between the two was unusually visible in early 2021: the Reserve Bank had cut the repo rate to four per cent while retail inflation ran above it, so deposit holders were earning a negative real return even though the money in their accounts kept growing.
- The nominal interest rate is the rate stated in the contract, measured in money and uncorrected for inflation.
- Real interest rate is approximately the nominal rate minus the rate of inflation.
- The bank rate is the standard rate at which the Reserve Bank buys or re-discounts eligible bills, under section 49 of the RBI Act.
- Terms of credit means the interest rate, collateral, documentation requirement and mode of repayment taken together.
- When inflation exceeds the nominal rate the real rate is negative, even though the borrower still repays more rupees than were borrowed.
No price index enters the stem, so no inflation adjustment has been made — which is what makes the rate nominal.
- Choosing the real rate because it sounds more technical, when the stem makes no reference to prices.
- Treating the bank rate as a synonym for the interest rate in general.
- Confusing one term of credit with the terms of credit as a whole.
As a define-the-rate item, or as a small numerical asking for the real rate given a nominal rate and an inflation figure.
Bank Rate implies the rate of interest
- (a) paid by the Reserve Bank of India on the deposits of Commercial Banks
- (b) charged by Banks on loans and advances
- (c) payable on Bonds
- (d) at which the Reserve Bank of India discounts the Bills of Exchange
Answer(d) at which the Reserve Bank of India discounts the Bills of Exchange
Settles the first wrong option here. Once the bank rate is fixed as the rate at which the central bank re-discounts bills, it plainly cannot be the general percentage by which any borrower's repayment exceeds the sum borrowed.
CDS_GK_2020_I_Q512020Which one of the following is not correct about Repo rate?
- (a) It is the interest rate charged by the Central Bank on overnight loan.
- (b) It is the interest rate paid by the commercial banks on overnight borrowing.
- (c) It is the interest rate agreed upon in the loan contract between a commercial bank and the Central Bank.
- (d) It is the cost of collateral security.
Answer(d) It is the cost of collateral security.
The neighbouring policy rate, tested a year earlier. Both items reward the same habit — checking whose loan the rate belongs to before answering, since a central-bank rate and a borrower's contract rate are not interchangeable.
- practice — not a real PYQ
A bank charges 9 per cent a year on a loan in a year when inflation is 7 per cent. The real rate of interest on that loan is approximately
- (a)16 per cent
- (b)9 per cent
- (c)7 per cent
- (d)2 per cent
Answer(d) 2 per cent — the real rate is roughly the nominal rate minus inflation, so 9 minus 7 leaves about 2 per cent of extra purchasing power for the lender.
- practice — not a real PYQ
Which one of the following best describes the bank rate in India?
- (a)The rate commercial banks charge their best customers
- (b)The standard rate at which the Reserve Bank buys or re-discounts eligible bills of exchange
- (c)The average rate paid on savings deposits by all scheduled banks
- (d)The rate at which the Government borrows from the market
Answer(b) the standard rate at which the Reserve Bank buys or re-discounts eligible bills of exchange — that is the statutory definition, and it makes the bank rate a central-bank rate rather than a general lending rate.