Wednesday, March 14, 2012

The little known effect of Bank Rate change!

On 13 Feb 2012, what did NOT appear to be a tectonic shift in the financial sector was the sudden spurt in bank rates by the Central Bank, perhaps unknown and unheard in the history. The Reserve Bank of India decided to change the Bank Rate, realigning it with the Marginal Standing Facility (MSF) rate. The upward shift of Bank Rate to 9.5 % was gigantic in real terms; as the same was kept unchanged at 6 % since April 2003. Perhaps such colossal leaps are unheard of in the history of the Central Bank and not many questions were asked by the alert media or finance experts. But, RBI just called it a “technical adjustment”, however, no such technical alteration was ever made in the bank’s history even when growth rates plummeted in the past or when inflation consistently touched double digits a few years back.  Perhaps, we are in an era of rates galore by the Central Bank; a base rate which could provoke clients; MSF rate, repo and reverse repo rates which could incite banker interests by spurring or draining liquidity. Then, has the RBI’s bank rates becomes innocuous now? With monetary policy signaling done through modulations in the reverse repo rate and the repo rates, Bank Rate now merely serve as penal rates for shortfalls in meeting reserve requirements for banks, or serve as reference rate for indexation purposes. Then, why this facade of rates including Bank Rate? Well it permits to obfuscate more than it reveals...  

With high bank rates, it could be the less alert Cooperative Banks that could face trouble as these institutions often unknowingly transgress the required reserve requirements, attracting penalties. While most of the other recent policy shifts by the Central Bank has enabled greater comfort for the beleaguered commercial banks, be it relaxation in prudential norms post the sectoral crisis, or the RBI gift by cut in CRR or the revised and magnified version of priority sector which could now include bank's credit to NBFCs or securitized loans as Priority Sector. But, the real bonanza for the Commercial Banks is the hidden one, that’s by defaulting in priority sector and parking it Rural Infrastructure Development Fund (RIDF) with NABARD, which fetches them the bank rate. Well no retailing headaches, no other transaction costs and no risk and an assured payment of a now attractive Bank rate.  
Well, the commercial banks including the foreign banks who are on a level playing field as regards the priority sector targets are concerned seemed to have really saved their skin. But, would the rural sector and development in hinterlands suffer? Would the credit absorption capacities stagnate with no supportive infrastructure being added on, well the obvious answer looks a certain yes !

Since 1995-96, the RIDF investments not only significantly addressed the eroding state in agriculture capital formation in the public sphere, but also brought about a significant change in upgrading the infrastructure in rural areas.  Economists and rural development experts have unequivocally exhorted a direct correlation between the index of infrastructure development and rural development. The RIDF manned by NABARD had made significant strides in fairly building the near absent rural infrastructure, which now serves as the lifeline in the rural hinterlands. While the expert’s assessments have suggested the need for exploring more and sustainable and cost effective resources for this infrastructure building process, the recent Bank rate changes could make it a costlier resource for the state government. In fact such high cost resource could push state governments away from accessing this resource which could deter the efforts at building primary and social infrastructure units in the hinterlands. And in hindsight, one sees that an innocuous rate like the present emasculated Bank Rate could do more harm for the hinterlands rather than help the cause.

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Works at NABARD for poor HH / was Research Affiliate at CDS, Tvm / was Visiting Faculty on microFinance for MBA students NMIMS, Mumbai.