Your loan interest rate still high after RBI cut? Know how long it takes for monetary policy transmission

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Shaktikanta Das, Reserve Bank of India Governor (Representational Picture)
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Even after the RBI’s surprise monetary policy rate cut last week, there are apprehensions about the pace of monetary transmission in the economy. RBI Governor Shaktikanta Das also convened a meeting of chief executives of public sector banks to discuss the issue of monetary policy transmission.

Monetary transmission is the entire process starting from the change in the policy rate by the central bank to various money market rates such as inter-bank lending rates; to bank deposit rates; to bank lending rates to households and firms; to government and corporate bond yields; and to asset prices such as stock prices and house prices, culminating in its impact on inflation and growth.

The monetary transmission would take place in two stages, Madan Sabnavis, Chief Economist, CARE Ratings, said to Financial Express Online. Firstly, deposit rates will come down, but since the deposits growth is sluggish, banks will only selectively lower rates in some time buckets, he said. Secondly, based on MCLR, lending rates will come down. Here too retail loans are likely to see more reduction than other loans, Sabnavis added.

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According to RBI, the immediate impact of a change in the policy rate is on the short-term money market rates, key financial markets and medium and long-term instruments. The impact of the policy rate on other market rates varies across tenors and instruments.

“Whenever there is policy rate reduction, it would be RBI’s expectation that monetary transmission does takes place,” said RBI Governor Shaktikanta Das, after the release of monetary policy statement last week. However, an earlier report by RBI said that the implicit assumption here is that bank balance sheets are strong and in a position to step up quickly the supply of credit in response to lower funding cost and higher demand for credit.

RBI introduced the Marginal Cost of Funds based Lending Rate (MCLR) system in 2016. It has further recommended to shift to an external benchmark system for better monetary policy transmission.

“Though, the idea is theoretically sound but needs to be analysed further, as such decisions should ideally be linked with cost of funds and external benchmark will be useful only at secondary level. Moreover, external benchmarks may not be related to the purpose of lending,” said Madan Sabnavis.

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