The Telegraph
Since 1st March, 1999
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Banks blunt rate-cut efficacy: RBI

Mumbai, March 31: The Reserve Bank of India (RBI) today voiced its concern on the poor ability of banks to pass on the benefits of changes in key rate cuts, which it said blunts the efficiency of the monetary policy in spurring growth.

The central bank in its ‘Report on currency and finance 2001-02’ was referring to the weak sensitivity of banks to change their lending rates following a reduction in the bank rate. RBI also drew banks’ attention towards maintaining their capital position, which it said could be a major challenge.

“In view of the weak sensitivity of bank lending rates to changes in the bank rate, the efficacy of monetary policy in reinvigorating growth runs up against a constraint,” the apex bank said. RBI was of the view that the critical issue in determining the effectiveness of signals emanating from changes in policy rate is the degree of pass-through (speed and magnitude of the response of market interest rate spectrum to monetary policy signals).

Between March 1998 and February 2003, the bank rate and the repo rate were cut by 4.25 per cent and 2.5 per cent respectively. In addition cash reserve ratio was reduced by 5.5 per cent over the same period. The repo rate was again slashed by 0.5 per cent in March this year.

The easing of the monetary policy was mirrored in a general softening of interest rates in money and government securities markets. However, the prime lending rate (PLR) of major banks remained sticky, RBI said.

“This suggests a low level of pass-through of changes in the policy rates on to lending rates, thereby blunting the efficacy of monetary policy,” the report observed.

It added that this relative downward inflexibility in the commercial bank interest rate structure can be attributed to a number of structural factors in the banking system. One such reason is that the average cost of deposits for major banks continues to be relatively high (6.25 per cent to 7.25 per cent).

While substantial portion of bank deposits remains in the form of long-term deposits at fixed interest rates, the other factors include high level of non-performing assets and 2.5-3 per cent non-interest operating costs, putting pressure on the cost of funds.

Regarding the challenges to be faced by banks, RBI explained that capital requirement of bank is likely to increase with the pickup in credit demand and the implementation of the New Capital Accord in 2006, which has laid greater emphasis on risk-sensitivity in capital allocation.

Banks would need to consider these factors while estimating their capital requirements. Given the depressed condition in the capital market and banks’ limited ability to generate sufficient funds internally, maintaining capital position in line with prescribed norms will be a major challenge,” it observed

RBI in the report was of the view that the country’s high fiscal deficit and uncertainty coming from the ongoing war could pose a risk to the country’s growth. “Concerns relating to the fiscal position and international political unrest remain downside risks that could constrain growth,” it pointed out.

The central bank said that the next phase of reforms should lay emphasis on the regeneration of growth in both agriculture and industry. While higher growth in agriculture will come from policy reforms promoting diversification and investment, in industry more needs to be done to allow faster restructuring and encourage investment.

“This would entail institution of more rapid bankruptcy procedures, flexibility in labour use, and reforms in urban land ceiling and small scale reservation policies,” the report noted.

In agriculture, the report called for reduction of most of the agricultural subsidies and ensuring better targeting of these that are essential for social welfare.

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