Arbitrary pricing by various actors, led by non-bank financiers, in money markets is delaying the transmission of monetary policy, according to Reserve Bank Deputy Governor Michael Debabrata Patra.
While other instruments such as commercial papers and certificates of deposit also contribute to delaying policy transmission, the central bank specifically identified NBFCs for the lag, saying that unlike banks, ”NBFCs, which have a loan portfolio equivalent to about one-fifth of outstanding bank loans, do not follow any uniform methodology for the pricing of their loans”.
Addressing treasury chiefs at a seminar hosted by the central bank, Patra said: “While some NBFCs use their own prime rates as benchmark interest rates, others use base rates or MCLR of banks as external benchmarks. A few of them don’t conform to any benchmark interest rate. This discretionary spread pricing hurts the transmission of monetary policy.”
With respect to the commercial paper segment, which generally rates the risk-free rate and issues are concentrated in maturities up to three months, with 95% of all issues in the highest rating category, a- He said, CP rates on instruments with maturities greater than three months are highly volatile and unduly influenced by idiosyncratic factors that may not be in sync with the prevailing monetary policy stance. In addition, about 40% of the resources mobilized through CPs come from NBFCs, including housing finance companies, which on-lend the funds after adding spreads and premiums, thus hampering the transmission of monetary policy. Similarly, the certificate of deposit (CD) market also has its own distortions, Patra said, adding “so once the monetary policy action and position is transmitted transparently to the market overnight , the transmission gradually loses strength and sometimes direction as it winds through the spectrum of the money market”.”In recognition of these obstacles, central banks are often persuaded to increase the magnitude of their rate changes disproportionately to the desired goal of ensuring an adequate amount of transmission, but doing so can increase borrowing costs disproportionately and lead to overpowered economic activity,” the Deputy Governor said. who heads the monetary policy department at the Mint Road office.
In normal times, a policy rate change takes up to a year for its maximum impact on growth and up to two years for its maximum impact on inflation, he said. These delays in transmission pose an existential dilemma for central banks. For example, seeing inflation rise in the future in her forecast, she raises interest rates. A few months later, the economy begins to slow down. Societal pressures are building up on the central bank to support growth and it is giving up control of inflation, and price pressures are intensifying and spiraling out of control, eventually killing growth. According to Patra, a large part of these mismatches emanate from frictions in the financial markets, especially in the money, G-Secs, forex and derivatives markets, especially at the synapses.
Impediments to the transmission of monetary policy are due to the microstructure of the market as well as how each segment fits into the continuum, he noted. Banks also play an important role in the delays, as the bank credit market accounts for almost half of the total flow of resources to the commercial sector. “Banks’ practice of changing deposit rates before changes in lending rates and rigid spreads have been major impediments to the transmission of monetary policy. On the one hand, term deposits are generally contracted at fixed rates.
“When the policy rate changes, term deposits are repriced at the margin – only with respect to deposits that mature and are rolled over and, on the other hand, the mandatory lending rate link for personal loans and MSME lending directly to external referrals, which move in sync with the repo rate is a response to these blockages in transmission arteries,” he said.
In the aftermath, there has been a growing preference among banks for external benchmark-linked loan pricing. This greatly accelerated transmission and made it complete in several categories of new loans. Asset quality, expected loan losses in credit portfolios and the stickiness of retail savings interest rates are additional sources of spread variability, highlighting the importance of financial system soundness for a smoother transmission.
With respect to the G-Secs market, this is conducive to faster transmission as participants anticipate political actions, the yield curve moves forward-looking, and macroeconomic developments play an important role in determining the shape of the yield curve. . In the corporate bond market that uses G-sec yields as a benchmark, only the highest quality issuers find favor and as a result, lower rated issuers are dependent on banks. Transmission to companies across the entire spectrum of ratings therefore remains incomplete and/or delayed. The microstructure of the G-sec market also tends to dampen transmission, Patra said.
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