Correct Option
The correct option is Reserves held by commercial banks will likely decrease.
Explanation
The Bank is the interest rate at which the Reserve Bank of India (RBI) lends long-term funds to commercial banks without any collateral. It is a quantitative instrument of monetary policy used to manage liquidity and control inflation. An increase in the Bank Rate signifies a contractionary monetary policy (or "dear money" policy).
Detailed Analysis
- Impact on Cost of Funds: When the RBI increases the Bank Rate, borrowing becomes more expensive for commercial banks.
- Impact on Reserves (Option b): As the cost of borrowing from the central bank rises, commercial banks are discouraged from accessing funds through this window. Consequently, the volume of borrowed reserves in the banking system tends to decline. To manage the higher cost of funds, banks may also tighten their liquidity positions, leading to a likely decrease in the overall reserves held.
- Impact on Lending Rates (Option c): To maintain their profit margins, commercial banks pass on the increased cost of funds to borrowers by raising their lending rates. Thus, loans become costlier, not cheaper.
- Impact on Credit Creation (Option d): Higher lending rates reduce the demand for credit among the public and businesses. Consequently, commercial banks will likely decrease (or slow down) their lending activities rather than increase them.
- Impact on Money Supply (Option a): Reduced lending and credit creation lead to a contraction in the overall money supply within the economy. Therefore, the money supply will decrease, not increase.
Key Takeaway: An increase in the Bank Rate increases the cost of borrowing for banks, leading to higher lending rates, reduced credit creation, a decrease in banking reserves, and a contraction in the money supply to curb inflation.