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RBI efforts to impart flexibility in bank interest rates

By Our Special Correspondent

MUMBAI MARCH 31. The Reserve Bank of India today stated its concerns in the delay in passing on of the soft interest rate measures announced by it to the consumers by the banking system.

"The prime lending rates (PLRs) of major banks remained sticky. This suggests a low level of pass-through of the changes in the policy rates on to the lending rates, thereby blunting the efficacy of the monetary policy,'' the Reserve Bank stated in its "Report on Currency and Finance 2001-02.''

"While the RBI is increasingly able to ensure orderly conditions in the financial markets, the crucial issue in determining the effectiveness of the signals emanating from the changes in the policy rate is the degree of `pass-through,' that is, the speed and the magnitude of the response of the market interest rate spectrum to the monetary policy signals,'' the RBI observed.

Between March 1998 and February 2003, the Bank Rate and the Repo rate were cut by 425 basis points and 250 basis points respectively. In addition, the cash reserve ratio (CRR) was reduced by 550 basis points over the same period. The Repo rate was cut by a further 50 basis points in March 2003. The easing of the monetary policy stance was mirrored in a general softening of interest rates in the money markets (with call rates declining by almost 325 basis points) and in the Government securities markets (with the yield on ten-year government securities declining by almost six percentage points). "However,'' the RBI stated, "the prime lending rates of major banks remained sticky.''

Over a medium term horizon, the spreads of lending rates of commercial banks over their average costs of deposits reveal a marginal narrowing down since 1996-97. "The spreads, however, still continue to be fairly large,'' it stated. The spreads of the Central Government's market borrowings over the banks' average cost narrowed from 5.2 per cent during 1990-96 to 4.4 per cent during 1996-2002 while that of other borrowers declined from 9.2 per cent to 8.1 per cent over the same period.

The RBI further stated that this relative downward inflexibility in the commercial bank interest rate structure can be attributed to a number of structural factors in the banking system, including, relatively high average cost of deposits, high overhang of non-performing assets, non-interest operating expenses, legal constraints and procedural bottlenecks and the large borrowing programme of the Government, over and above the SLR requirements.

"In order to overcome these rigidities and to impart more flexibility to the interest rate structure, the RBI has recently initiated a number of measures. The banks were encouraged to introduce a flexible interest rate system option for all new deposits and urged to review and announce the maximum spreads over PLR,'' the RBI stated.

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