The Reserve Bank of India (RBI) is getting tougher on extending unlimited credit to the country’s banks to try to ensure they push interest rate cuts through the financial system and to stop them from making what one official called a “mockery” of its operations.
India’s commercial banks readily borrow from the central bank at the policy rate but then lend that money out at a high rate, in what RBI Governor Raghuram Rajan describes as a culture of “lazy banking.”
The RBI argues this reduces the effectiveness of its monetary policy decisions and the cheap funding rates for banks are not passed on to retail and corporate borrowers at a time when the economy is only gradually recovering from a slowdown.
“They have made a mockery of our monetary policy transmission framework,” one official familiar with the RBI’s thinking said.
Another senior official said the RBI wanted to end a “whenever you want, you come” mentality that many lenders had regarding funding.
“It is not actually the responsibility of the central bank to always keep the tap open,” he said.
Reducing banks’ reliance on overnight funding from the central bank is a key part of Rajan’s goal of reforming Indian money markets unveiled in January last year.
The RBI believes that banks which manage their assets and liabilities without always tapping the central bank for cash will be more efficient and so will react more quickly to changes in monetary policy through their deposit and lending rates.
However, only three of 45 commercial banks have cut base lending rates since the RBI’s surprise easing this month, hurting the government’s drive to lift business investment.
The sources said the RBI is adamant it will not inject additional liquidity after loosening the statutory liquidity ratio further to give banks more available cash. The ratio is the proportion of deposits that banks must hold in government bonds, cash or gold.
It also ruled out for now introducing longer-term repos beyond the seven-day and 14-day repos.
A firm RBI stance risks increasing market volatility at a time when analysts expect the central bank to cut rates by another 50 to 75 basis points this year after last month’s 25 basis point cut.
The overnight cash rate surged to as high as 26 percent this month. Ideally, it should closely track the RBI’s 7.75 percent repo rate, the key policy rate.
Tough-love tactics by China’s central bank in 2013, seen as a way to stop banks from using short-term funds to mask their activities in risky wealth management products, also sparked spikes in short-term lending rates.
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