‘What’s the point in cutting rates if banks don’t transmit?’

It took two out-of-cycle policy rate cuts and two status quo monetary policy announcements for the banking regulator to finally get banks to cut their lending rates. RBI Governor Raghuram Rajan in an exclusive interview with BusinessLine, says India is the only country where banks tie their lending rates to something they themselves fix, instead of an external benchmark. Excerpts from the interview:

When do you expect banks to cut rates? Bankers said their cost of funds has not come down, while you maintain that it has. Where is the gap?

I have no expectations. I am not the owner, just a regulator and monetary authority. We have done what we need to do as a regulator and banks need to figure out what they need to do. Are they saying that the monetary policy has no effect on them? (laughs). You have to take everything I say and they say with appropriate amount of salt.

There are some aspects of the balance sheet which will take time to adjust, some of which are slow moving and some of which are fast. But some of the banks are borrowing from us at 7.5 per cent and those rates are down by 50 points over the past three months.

Bankers say the borrowing at repo rate is a small factor of rate-movement decision.

Yes. They will say that. But some of them have reduced deposit rates. So they can reduce their deposit rates, but not their cost of funds? That’s a hard argument to make. My sense is they are saying give us time. I am not pressing them and telling them to do it today. I am not their owner. But transmission has to take place. What is the point in cutting rates if they don’t transmit it? It is not as though the economy is going to look at the RBI cutting and stimulate itself.

Banks have expressed their concern about moving to a marginal cost method for pricing interest rates. Your views

There are two issues here. One is the issue of transition path. And the other is one of cultural differences. Regarding the transition path, it is not something they can do overnight. It will take a little bit of time. But across the world, banks tie their lending rates to an external benchmark such as LIBOR, for instance.

We are the only country where banks tie their lending rates to something they themselves fix — which is their own cost of funds. Abroad, banks understand that when the benchmark falls, they have to adjust rates for all the borrowers.

Banks have to adjust to that or they will be dis-intermediated — because borrowers are not going to keep coming back if you keep your base rates high when market rates are cheaper. This is what many big borrowers are doing today. This is a change that has to happen.

The forex reserves position is at about $343 billion. Is that a comfortable level?

Yes, it is perfectly comfortable. I am sure there are some requirements they are not sufficient for. I have never seen forex reserves as our first line of defence in case of any international turmoil. I have said repeatedly, our first line of defence is good policy.

If our policy is good, investors will stay invested. It is the whole gamut of policy, be it fiscal, tax, or judicial. All this will help create an environment for investors to stay invested. If we do not maintain the environment, no forex reserves can help. Even with small line of reserves, with good policy environment, we can be fairly safe.

What is the status on the independent public debt management agency?

I think the Government wants to notify it and once it’s notified there will be a committee looking at how it will be composed. Then there will be debate and will take forward it to implementation. I have said that we have no problem with an independent debt management agency which is truly independent. I don’t believe in these conflicts of interest stories because everyone has conflict of interest unless we are fully independent and nobody is fully independent.

Nevertheless, it is a good development and when it starts it will probably draw resources from both the Government as well as the RBI. I think the Government is on board on these issues.

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