Improving monetary transmission

IN APRIL 2016, the Reserve Bank of India (RBI) introduced the marginal cost of funds based lending rate (MCLR) system to improve the monetary policy transmission mechanism in India.

But this shift may not have yielded the desired results, suggests a new report by an internal study group formed by the RBI.

The report finds that both the extent as well as the pace of reduction in the MCLR have been uneven.

As shown in Chart 1, transmission has been quicker on fresh rupee loans, while on existing loans it has been partial. A large part of this transmission in rates has actually occurred in the post-demonetisation period, as shown in Chart 2.

The report also finds that transmission to the weighted average lending rate (WALR) on outstanding rupee loans is better in the case of private sector banks than public and foreign banks (Chart 3).

The extent of transmission also varies across sectors. As shown in Chart 4, the decline in the WALR on outstanding loans during December 2014-June 2017 was greater for large industrial entities than retail housing and retail vehicle loans.

Transmission to lending rates also tends to vary over monetary policy cycles. As shown in Chart 5, it was higher during the tightening phase and lower during the easing phase.

On the suitability of using another instrument as a benchmark in the credit market, the report finds two market-based possibilities — the T-bill rate and the CD rate (Chart 6). “Monetary policy transmission has been strong in both these instruments. A cumulative 200 bps cut in the repo rate since January 2015 has been by and large transmitted to these rates,” it says.