Monetary transmission improves but credit growth remains muted

Amidst expectations that the Reserve Bank of India will maintain status quo on interest rates in the bi-monthly Monetary Policy Review on August 6 as inflation continues to harden, data indicate that monetary transmission has improved since the introduction of external benchmark-based pricing of loans but credit growth continues to be low.

“Over the years, the Reserve Bank’s efforts in improving transmission to deposit and lending rates of banks have started to bear some fruits particularly with the introduction of the external benchmark system,” said an article in the Reserve Bank of India Bulletin for July 2021.

The share of outstanding loans linked to external benchmark increased from as low as 2.4 per cent during September 2019 to 28.5 per cent during March 2021, it said.

In response to the cumulative reduction of policy repo rate by 250 basis points, the one-year median marginal cost of funds-based lending rate of scheduled commercial banks declined by 155 bps during February 2019 to June 2021.

“Transmission to lending rates has improved considerably in the current easing phase (up to May 2021) and more so since October 2019 when there has been a complete pass-through of repo rate cuts to the weighted average lending rate on fresh rupee loans,” the article said.

The repo rate is already at a record low of 4 per cent through rate cut of 75 bps in March 2020 and 40 bps in May 2020 and the RBI has kept its stance unchanged in the last six policy meetings.

Rate cuts

According to a report by CARE Ratings, while the RBI has cut rates by 115 bps during March and May 2020, the median MCLR of banks has been reduced by 97 bps over a span of 17 months.

But several factors impede monetary transmission to deposit and lending rates of banks, the RBI article noted, adding that these include the mismatch of banks’ assets and liabilities as well as competitive pressure from small savings schemes.

Legacy of internal benchmark linked loans — which together comprised 71.5 per cent of outstanding floating rate rupee loans as at end-March 2021 — impeded transmission.

Deterioration in the health of the banking sector and the expected loan losses in credit portfolios induced large variability in spreads in pricing of assets have also impacted monetary transmission. Another factor is that NBFCs do not follow a uniform methodology for pricing of loans.

At the current juncture, economic uncertainties from the second wave of the Covid-19 pandemic has also made banks more cautious in extending loans while demand for credit is also subdued in many segments.

RBI data show that gross bank credit growth declined to 5.8 per cent in June 2021, from 6.2 per cent in June 2020. Non-food credit growth was also lower at 5.9 per cent in June 2021 compared to 6 per cent a year ago and there was a contraction in credit growth for industries.

“The bank credit growth has been moderate which can be ascribed to the risk aversion and regional lockdowns imposed by states this year to curb the spread of coronavirus amid the second wave of the pandemic that started in April 2021,” said CARE Ratings said in another report.

It expects credit growth for 2021-22 to remain in low double-digit and growth is expected in the second half of the fiscal led by improvement in the economy and ECLGS support.

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