Towards better transmission

What is, on the face of it, a mere retention of the status quo , is a serious attempt to ensure that rate cuts are passed on to borrowers. The decision of Reserve Bank of India Governor Raghuram Rajan to leave the repo rate untouched comes after two successive reductions totalling 50 basis points, which failed to nudge banks into lowering their lending rates. The central bank has now sought to address this issue by proposing changes in the way banks compute their base rate, that is, the rate against which lending rates are benchmarked. There is no uniformity in the manner in which banks currently calculate their base rate, with some arriving at this using the average cost of funds, and others on the basis of the marginal or blended cost of funds. The marginal cost of funds, which is pegged on the cost of incremental deposits, is better synced with changes in the repo rate. Calculations that are based on the average funds perforce have to factor in older deposits, including those sourced at rates that prevailed earlier. Unlike this, the RBI’s decision to prod all banks to the use of marginal cost to calculate the base rate will ensure that the rate charged to borrowers is in line with its own policy.

While this move will have an impact in the long term, the question is whether it will have an immediate impact on transmission. With both deposit and credit growth sluggish this year, banks may be reluctant to cut rates further and risk earnings erosion. But the RBI has made it clear that future rate cuts hinge on the pace at which the benefits are passed on to borrowers. They will also depend on other factors such as the RBI’s future reading on inflation, the government’s success in removing infrastructure bottlenecks and the US Federal Reserve’s policy.

The proposal to improve the remuneration of non-executive directors in both private and public sector banks is welcome. This will help attract and retain the best talent at the top. Also, laying down that bank boards must focus on important strategic issues such as business strategy, risk, consumer protection and human resources instead of wasting time on mundane issues that were mandated by calendar reviews, is the right way to go. Allowing top corporates to issue rupee bonds abroad will help meet the funding needs of Indian companies. For some time now, there has been considerable interest in Indian paper abroad, reflected in the successful rupee bond issuances of some multilateral institutions. This will help Indian companies raise money from abroad at lower rates and without the forex risks that prevail in the case of external commercial borrowings.

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