Over the years, the Reserve Bank of India has come up with new measures for the successful transmission of monetary policy to the bank lending rates. Because at lower interest rates, people are likely to borrow and spend more. The more the money circulates in the economy, the higher is the chances of the country’s economic growth. However, it depends on how fast the transmission mechanism works.
Recently, the central bank has slashed the repo rate for the 5th consecutive time. Despite the slew of measures RBI comes up with, there has been incomplete pass-through of transmission most of the time, owing to several reasons.
More than 50 percent of the total deposits in banks are term deposits that mostly have fixed interest rate and transmission is effective only in fresh deposits. Moreover, due to high operating expenses of savings accounts and stressed balance sheets, banks don’t have the means to decrease their deposit rate.
Effective monetary transmission is also obstructed by weak balance sheets making the banks difficult to deal with troubled loans. In light of the slow transmission of monetary policy, RBI recently announced its intention to mandate the banks to link their floating interest rate to an external benchmark.
The external benchmark would be RBI’s repo rate. Several banks have already launched repo-linked lending rate products. RBI’s move in mandating the banks to reset their interest rates under an external benchmark at least once in three months will undoubtedly help in the transmission of the RBI’s monetary policy. With this, the banks’ balance sheets will most likely revive which will, in turn, improve their willingness to set their lending rates at par with RBI’s policy rates. The government has been initiating various measures to strengthen the financial infrastructure of the country. And enabling effective monetary transmission can boost the government in its endeavour.