What Are The Limitations Of The Discount Policy?

The discount policy is effective if the following conditions are fulfilled.

1. The discount policy is successful only if the money market is compact, uniform and sensitive to the charges in the bank rate. When the bank rate increases the market rate must also increase and vice versa. Since the money markets in the developing countries are not sensitive and organized, the bank rate therefore does not effectively influence the volume of credit particularly in these countries.

2. The role of discount rate in regarding the volume of bank reserves is reduced in importance if he yield on assets is higher than the discount rate. In Pakistan for instance the margin of profits usually remains higher than the bank rate. The member banks often misuse the privilege of borrowing and obtain short terms loans from the central bank even with a rise in discount rate.

3. If the member banks have excess cash reserve with themselves, they will not approach the central bank for loan. The change in the discount rate will therefore have little effect on the cash reserves of the bank.

4. The rise in the bank rate may not reduce the volume of bank reserves if deficit financing is adopted by the government.

5. If the bill markets are not developed and organized in the country the bank rate will be weak instrument of monetary policy.