India: Banks need strengthening for full monetary policy impact: RBI

  • Soured loans and weak capital positions mean Indian banks cannot cut their interest rates in step with the central bank’s main policy rate, reducing the effectiveness of monetary policy, the Reserve Bank of India said in a working paper.
  • The paper, co-authored by RBI monetary policy committee member Janak Raj and three others, said concerns about asset quality must be addressed and lenders’ capital positions strengthened to ensure policy actions have their full impact.
  • “The study finds that a robust credit channel of monetary transmission exists in India. Its efficacy, however, is impaired by poor asset quality but reinforced by better capital position of banks,” the authors said in the paper.
  • The paper also found that in the short run, transmission of interest rate changes by the RBI to businesses and households via the credit channel was stronger among state-run banks than private banks.
  • “The accommodative stance of monetary policy and reduction in the policy repo rate (starting from 2019) helped cushion the credit deceleration. In the absence of a sharp cut in the policy repo rate, the slowdown in credit growth would have been far more severe,” the paper suggests.

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