Reasons for Slow Monetary Transmission

Reasons for Slow Monetary Transmission

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Money happens to be a raw material of the banks that is absolutely necessary for its everyday operations. In any industry, at whatever point a significant provider lessens the costs of the unrefined components it supplies, it triggers cost cuts downstream. Now, the degree of market competition determines whether or not a bank passes on the lower interest rate to its customers. If a single bank holds monopoly power in the sector, it is not obligated to immediately pass along the lower costs to its customers. As a result, it may take some time for the benefits of RNI rate cuts to be distributed. Let's look at a few of the reasons why this is the case:

1. Due to the fixed interest rate on deposit contracts, banks also find it difficult to reduce lending rates in the short term after a policy rate cut. Additionally, there is competition from small savings instruments, making it difficult to lower depositor rates.

2. The pressure placed on banks to increase equity financing and decrease risky debt financing is another issue that hinders financial transmission. This issue is especially pertinent to India's current financial situation.

3. The U.S. financial crisis, which brought to light the dangers of debt financing and excessive reliance on it, prompted the new focus. A convenient way for banks to increase their interest margins during a policy rate cut is to lower deposit rates rather than loan rates. In addition, this opens the door to increased profits, which are actually a form of equity that enhance their balance sheets.

4. The number of loans that banks have determines the amount of equity they need. Banks run the risk of losing some customers if they don't act quickly to lower loan rates. Because it slows down loan growth and necessitates an increase in equity, the current financial climate accepts that loss.

5. As a result, rate cuts won't happen as quickly if banks are under pressure from regulators to increase their capital buffer.

6. Transmission is also hampered by the banks' government ownership. A government bank's disinvestment program and decision to infuse equity determine its capacity to increase equity.

7. Because banks do not have any control over this decision, they raise the interest margin and slow the growth of loans. As a result, the decision made by the government to strengthen the banks' balance sheets determines the monetary transmission in this instance.

8. A CRR cut has been suggested by some commercial banks as a prerequisite for monetary transmission traction. In addition to introducing additional liquidity into the system, a significant reduction in CRR frees up resources for lending and assists banks in passing on rate cuts without affecting their net interest margin.

Because banks do not have any control over this decision, they raise the interest margin and slow the growth of loans. As a result, the decision made by the government to strengthen the banks' balance sheets determines the monetary transmission in this instance. The Reserve Bank of India frequently employs this monetary policy approach to control market inflation and manage the economy's liquidity after taking into account the state of the Indian economy and inflation levels. However, if the banks aren't ready to pass on the rate cut to their customers, this procedure might not work. The bottom line is that banks are unlikely to match the RBI's rate cuts, with the exception of the delay in monetary transmission. However, in order to encourage banks to lower rates in the future, additional rate cuts and liquidity support measures are required.