Why is monetary policy transmission (MPT) slow in India?
(Please see comments below)
Downward stickiness of lending rates: Whenever Reserve Bank of India (RBI) decreases policy rates, banks do not pass on the benefit of lower interest rates to borrowers
immediately. The pass-through of policy rates to lending rates is rather slow. Why?
Bank deposit rates are fixed, not floating. When
interest rates decline, deposits contracted at higher rates in the past
continue to enjoy those rates till maturity. So, banks' cost of funds will not
come down immediately.
In contrast, when banks cut lending rates, they
have to cut rates on all loans with immediate effect. Most of the bank loan
rates are floating. In addition, Indian banks are suffering from a high share
of bad loans.
Interest rates are set by the government on small
savings, which restrict the reduction in bank deposit rates.
Persistence of large market borrowing programme of
the governments hardens interest rate expectations and complicates the transmission.
When RBI decreases policy interest rates, the banks are slow to decrease lending rates. But when RBI raises policy rates, they are quick to increase lending rates. This divergent response of banks to RBI policy rate
changes decreases the effectiveness of RBI’s monetary policy transmission.
The introduction base rate system of loan pricing
in banks in July 2010 has not helped matters much.
Many experts are of the view that banks are
protecting their margins by not passing on the benefits of lower interest costs,
immediately, to borrowers.
What India needs right now to make the monetary
policy transmission more effective is more competition in the banking system.
But the RBI and the Indian government are very reluctant to issue new bank licenses.
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One more reason I can add here for Indian banks not passing on the benefit of lower policy rates to borrowers (in the current Indian context when RBI has cut policy rate by 50 basis points in the past couple of months) is that many banks are saddled with large amount of bad assets. These bad loans, including the restructured loans, are killing banks' profit margins--which forces banks to continue to charge higher rates from disciplined borrowers in order to earn higher interest income.
ReplyDeleteThe popular perception is that Indian banks are rather slow in cutting lending rates even after RBI cuts policy rates. And whenever RBI hikes rates, banks are very quick to raise their lending rates, it is often reported. This has been corroborated by several RBI panels. A recent IMF study too endorsed this view with some facts. But what are the reasons for this seemingly illogical behavior. I present some of my random thoughts below.
ReplyDeleteIt may be noted that the RBI has already cut its policy rate by 50 basis points in the past three months. It's reported that only a few banks have cut their base rates or BPLRs meagerly following the RBI's rate cuts.
ReplyDelete