A higher credit flow from banks doesn’t mean higher investment by India Inc. Instead, companies are using credit lines to finance their current liabilities while investments take the back seat, the Reserve Bank of India (RBI) said in a study on monetary policy transmission.
While credit flows from banks depend on the liquidity position of banks that the firms are attached to, an increase in credit may not always find its way towards increasing investments, the RBI report said. Credit growth on a year-on-year basis was 6.1 per cent in 2020, as against 7.1 per cent in 2019 while deposit growth was higher at 11.3 per cent and 10.1 per cent, respectively. The RBI has slashed key policy rate — repo rate — by 400 basis points from 8 per cent to 4 per cent since January 2014. However, investments in new projects and capital expenditure have stagnated in the last couple of years as companies have been focussing on repayment of debt.
In other words, while the RBI has pushing for faster rate cut transmission, borrowers ignored investments in new projects and used the credit to meet the liabilities. “In addition to slow or lagged monetary policy transmission, an increase in credit may not always find its way towards increasing investments. Firms may use their credit lines to finance their current liabilities rather than undertaking capital formation,” it said. Further, banks respond to changes in money market spreads faster and better than changes in policy rate, it said. The RBI study said that firms, which borrow from less liquid banks do not increase their capital expenditure, while current liabilities increase for these firms. “This tells us that firms channel their credit lines towards meeting current liabilities while investments take a back seat,” it said. On the other hand, the study said that firms who borrow from relatively more liquid banks are more responsive to increasing their capital spending when the lenders increase their supply of credit.
Policies directed at influencing the term spread could complement policy rate changes in strengthening rate transmission, it said. Further, in the presence of a weak balance sheet channel of policy transmission, an expansionary monetary policy could help firms in meeting their current liabilities rather than raising their fixed capital expenditure, it said. Thus, capital infusion in banks can make critical difference in improving credit supply and capital formation, the study said.
In 1994, the RBI deregulated lending rates, and banks were required to declare Prime Lending Rates (PLR). But PLR turned out to be rigid and inflexible in relation to the overall lending rate which led to the introduction of Benchmark PLR (BPLR). This regime was also marked with limited transmission success, as banks were often lending at sub-BPLR rates. As a corrective practice, the RBI introduced a base rate system in 2010 based on the cost of borrowing. However, the transmission through base rate turned out to be weak primarily because of banks’ spread adjustments. To improve transmission, a marginal cost-based lending system (MCLR) was introduced in 2016, and was further refined by linking all new floating rate personal or retail loans and floating rate loans to micro and small enterprises extended by banks to external benchmarks since October 2019.
However, some evidence suggests that the MCLR action has not been fully transmitted to corporate borrowings, and there was evidence of long and variable lags, the study said.
College of Supervisors set up
Mumbai: As part of an initiative to further strengthen supervision over regulated entities, the RBI has set up a College of Supervisors (CoS) to augment and reinforce supervisory skills among its regulatory and supervisory staff — both at entry level and on a continuous basis.
This was done to facilitate the development of unified and focused supervision by providing training and other developmental inputs to the concerned staff, the RBI said.
Former RBI Deputy Governor NS Viswanathan is chairperson of the CoS. The other members include ex-SBI Managing Director Arijit Basu, former HDFC bank Deputy MD Paresh Sukthankar, IIM Bangalore professor
S Raghunath, IIM Ahmedabad professor Tathagata Bandyopadhyay and IGIDR professor Subrata Sarkar. —ENS
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