Money & Banking

‘Credit channel of monetary policy transmission robust in India’

Mumbai | Updated on December 15, 2020

The credit channel of monetary policy transmission is robust in India, according to a Reserve Bank of India (RBI) working paper.

“Its efficacy, however, is impaired if there is a deterioration in asset quality but is reinforced by better capital position of banks,” the paper said.

The paper assessed that an increase (decrease) in policy rate by 100 basis points causes the credit to decline (increase) by 1.95 per cent with a lag of six quarters, validating the existence of a robust credit channel of monetary transmission in India.

Plays a critical role

The paper emphasised that in a bank-dominated financial system such as India, the credit channel plays a critical role in transmitting monetary policy impulses to the credit market and from thereon to the real economy.

The stressed asset ratio impacts credit growth negatively, suggesting that banks with higher stressed assets are forced to curtail their credit growth.

The working paper has been put together by Janak Raj (former Executive Director, RBI), and RBI officers Deba Prasad Rath (Officer-in-Charge), Pratik Mitra (Director) and Joice John (Assistant Adviser).

The authors observed that controlling for asset quality, in the short-run, the credit channel of monetary transmission of public sector banks is stronger relative to that of private sector banks.

The paper assessed that the coefficient of nominal GDP growth of private sector banks was higher than that of public sector banks, suggesting that the behavior of private sector banks is more pro-cyclical than that by public sector banks.

In the case of foreign banks, only economic activity and deposit growth were found to be the drivers of credit growth; the credit channel coefficient was statistically insignificant, it added.

Worsening asset quality

The paper said the credit deceleration in India since 2013, in part, could be attributed to a gradual worsening of asset quality.

“Other factors contributing to the slowdown of credit growth include a slowdown in economic activity and deposits.

“However, the accommodative stance of monetary policy and reduction in the policy repo rate (starting from 2019) helped cushion the credit deceleration.” it added.

The authors noted that in the absence of a sharp cut in the policy repo rate, the slowdown in credit growth would have been far more severe.

“The credit growth slowdown would have been bolstered to some extentif banks had maintained higher levels of capital position.

“Therefore, for monetary policy actions to have their full impact on the credit channel, it is imperative that the asset quality concerns of banks are addressed and that their capital positions are strengthened,” the authors said.

Published on December 15, 2020

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