Indian Journal of Economics and Development

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Monetary Policy Transmission through Banking Channel: Is India Ready for External Benchmarking?


Affiliations
1 School of Management Studies, Mody University, Laxmangarh, Sikar, Rajasthan, India
 

Objectives: This work assesses the effectiveness of various internal as well as external benchmarking systems with respect to transmission of RBI’s monetary policy rates to bank lending rates in India.

Methods/Analysis: This study has used the database on Indian Economy published by Reserve Bank of India (RBI). A number of independent variables, including the lagged variants of some of them, have been used to perform the multivariate regression. Proper segregation of data has also been done to account for the impact of the major economic event of November 2016 namely ‘demonetisation of higher denomination currency notes’ in India.

Findings: Though this study finds that, barring the highly ineffective Benchmark Prime Lending Rate (BPLR) system, a significant progress has been made by Reserve Bank of India (RBI) in monetary policy transmission first through Base Rate System and then through Marginal Cost of funds based Lending Rate (MCLR) System. However, this paper finds that India is not yet ready to adopt the external benchmarking of lending rates, as proposed by an internal study group of RBI in 2017, primarily due to following reasons (a) Volatility issue of the proposed benchmark rates; (b) Lack of volumes, depth and maturity making them susceptible to manipulation; (c) Infeasibility of linking liability side and unilateral linking of asset side may hit banks’ profitability badly; (d) Manipulation through spreads would still be possible; (e) Possibility of draconian centralization of powers in the hands of RBI may be dangerous for the economy; (f) Possibility of lobbying by banking industry to influence RBI cannot be ruled out; and (g) It would be against the spirit of liberalization.

Application: This paper not only attempts to give a perspective with respect to prevailing and proposed systems of monetary policy transmission, but also encourages further research, so as to facilitate better policy formulation by RBI, which is evaluating all possible options, including external benchmarking of lending rates, in quest of perfecting the monetary policy transmission in India.


Keywords

Monetary Policy Transmission, Interest Rate Pass-through, MCLR, External Benchmark Rate.
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  • V. Acharya. Monetary transmission in India: why is it important and why hasn’t it worked well? Inaugural Aveek Guha Memorial Lecture. 2017; 1-15.

  • Report of the expert committee to revise and strengthen the monetary policy framework. Reserve Bank of India, Mumbai. 2014; 1-130.

  • Report of the internal study group to review the working of the marginal cost of funds based lending rate system. Reserve Bank of India, Mumbai. 2017

  • J.K. Khundrakpam. Examining the asymmetric impact of monetary policy in India. Margin, Journal of Applied Economic Research. 2017; 11(3), 290–314

  • A. Chavan, R.R. Vaidya. Financial liberalization in India and the bank lending channel of monetary transmission. South Asia Economic Journal. 2003; 4(2).

  • A. Anagnostou, S. Papadamou. Environment and Planning. Government and Policy. 2016; 34, pp. 795 – 815.

  • N. Sengupta. Sectoral effects of monetary policy in India. South Asian Journal of Macroeconomics and Public Finance. 2014; 3(1), 127–154.

  • Statistical tables related to database on Indian economy. Reserve Bank of India, Mumbai. 2017.

  • R.N. Paramanik, B. Kamaiah. A structural vector auto regression model for monetary policy analysis in India. Margin—Journal of Applied Economic Research. 2014; 8(4), 401–429.

  • A. Aleem. Transmission of monetary policy in India. Journal of Asian Economics. 2010; 21(2), 186–97.

  • M.D. Patra, M. Kapur. A monetary policy model for India. Macroeconomics and Finance in Emerging Market Economies. 2012; 5(1), 16–39.


Abstract Views: 250

PDF Views: 160




  • Monetary Policy Transmission through Banking Channel: Is India Ready for External Benchmarking?

Abstract Views: 250  |  PDF Views: 160

Authors

Surendra Singh Rajpurohit
School of Management Studies, Mody University, Laxmangarh, Sikar, Rajasthan, India

Abstract


Objectives: This work assesses the effectiveness of various internal as well as external benchmarking systems with respect to transmission of RBI’s monetary policy rates to bank lending rates in India.

Methods/Analysis: This study has used the database on Indian Economy published by Reserve Bank of India (RBI). A number of independent variables, including the lagged variants of some of them, have been used to perform the multivariate regression. Proper segregation of data has also been done to account for the impact of the major economic event of November 2016 namely ‘demonetisation of higher denomination currency notes’ in India.

Findings: Though this study finds that, barring the highly ineffective Benchmark Prime Lending Rate (BPLR) system, a significant progress has been made by Reserve Bank of India (RBI) in monetary policy transmission first through Base Rate System and then through Marginal Cost of funds based Lending Rate (MCLR) System. However, this paper finds that India is not yet ready to adopt the external benchmarking of lending rates, as proposed by an internal study group of RBI in 2017, primarily due to following reasons (a) Volatility issue of the proposed benchmark rates; (b) Lack of volumes, depth and maturity making them susceptible to manipulation; (c) Infeasibility of linking liability side and unilateral linking of asset side may hit banks’ profitability badly; (d) Manipulation through spreads would still be possible; (e) Possibility of draconian centralization of powers in the hands of RBI may be dangerous for the economy; (f) Possibility of lobbying by banking industry to influence RBI cannot be ruled out; and (g) It would be against the spirit of liberalization.

Application: This paper not only attempts to give a perspective with respect to prevailing and proposed systems of monetary policy transmission, but also encourages further research, so as to facilitate better policy formulation by RBI, which is evaluating all possible options, including external benchmarking of lending rates, in quest of perfecting the monetary policy transmission in India.


Keywords


Monetary Policy Transmission, Interest Rate Pass-through, MCLR, External Benchmark Rate.

References