Close to the heels of the Fed and the ECB, RBI has decided to follow a softer interest rate regime for India. In the prevailing situation where there is ample amount of liquidity present in the banking system, the RBI has initiated a cut in the bank rate as well as the CRR and has made it clear that it would be fine tuning its interest rate policy as and when the circumstances warrant. While RBI has initiated these major changes, some bankers are of the opinion that these changes are not up to the mark. Are the reductions too low? Has the RBI announced these measures too late?
On October 29, 2002, Dr.Bimal Jalan, Governor of the Reserve Bank of India, in his mid-year review, has announced certain changes in the monetary and credit policy measures for 2002-03. Most important among them were the 25-basis points reduction in the Bank Rate and in the Cash Reserve Ratio (CRR). A section of the leading bankers are reportedly voicing that the reduction is too low and too late.
The direct effect of a reduction in the Bank Rate is to reduce the borrowing cost of funds to the banks from the Reserve Bank of India (RBI). If the objective is to be reached, the following conditions should be fulfilled: (i) the banks should be short of funds; (ii) they should be facing unsaturated demand for credit; and (iii) they should approach the RBI for funds. These conditions are not met in the present Indian context. There are two reasons. First, the banks are saddled with liquidity. Credit off-take has been much lower than the accretion to deposits. There is, therefore, no need for the banks to approach the RBI for funds for lending to the ultimate borrowers. Second, better creditworthy borrowers are now able to obtain bank funds at the rates substantially below the Prime Lending Rates (PLR). Recently, a company has raised a 15-year loan at a rate lower than the Bank Rate, which itself is less than the PLR. In this scenario, a downward change in the Bank Rate has no real relevance. Therefore, the magnitude of the reduction, whether it is 25-basis points or even 100-basis points, is immaterial. |
