Monetary transmission to banks' interest rates may strengthen further, says RBI

Mumbai: The Reserve Bank's endeavour to improve monetary policy transmission by banks has gained traction, especially with the advent of the EBLR regime in October 2019 and the pace is likely to strengthen further, an RBI article said.

Earlier, the internal benchmark-based lending rate regimes had faced a multitude of issues, such as arbitrariness in the calculation of the base rate/MCLR and spreads; long reset clauses, which inhibited efficient monetary transmission, the article published in the RBI Bulletin April 2022 said.

Monetary policy transmission to lending and deposit rates has improved in the external benchmark linked lending rate (EBLR) regime, facilitated by an accommodative monetary policy stance, large surplus liquidity conditions and subdued credit offtake.

The framework for pricing of loans under an external benchmark system improved the extent and pace of adjustment in lending and deposit rates in response to changes in policy repo rate.

The external benchmark linked lending rate (EBLR) system has also accelerated the pass-through to MCLR-linked loans, as changes in the benchmark rates lead banks to proactively adjust their deposit rates to protect their NIMs, thereby improving transmission to overall lending and deposit rates, the article said.

Thus, the impact of the introduction of external benchmark-based pricing of loans on monetary transmission has been felt across various sectors, encompassing even those sectors that are not directly linked to external benchmark-based loan pricing and this has been corroborated by empirical analysis undertaken in this paper.

Looking ahead, it said, "the proportion of loans linked to external benchmarks is expected to increase further along with a commensurate fall in the internal benchmark linked loans. Coupled with shorter reset periods, monetary transmission to banks' interest rates can, thus, be expected to strengthen further".

The central bank said the views expressed in this article are those of the authors and do not necessarily represent the views of the Reserve Bank of India.

Moreover, Flagging risks of disruptive spillovers from geopolitical hostilities, the RBI article said India faces these challenges from a position of strength built on broadened vaccine coverage, financial sector resilience and robust exports.

The article on 'State of the Economy', published in the April 2022 RBI Bulletin, said India enters Samvat 2079 having crested the third wave of the pandemic with economic activity returning to speed in several sectors.

These gains are, however, at risk from disruptive spillovers from geopolitical hostilities as increasingly evident in inflation prints, tightening financial conditions and a terms of trade shock accompanied by portfolio outflows.

"India faces these challenges from a position of strength built on broadened vaccine coverage, financial sector resilience, robust export and remittances and fiscal reprioritisation to spur capital spending on infrastructure," it noted.