Objectives: This work assesses the effectiveness of various internal as well as external benchmarking systems with respect to transmission of RBI’s monetary policy rates to bank lending rates in India.
Methods/Analysis: This study has used the database on Indian Economy published by Reserve Bank of India (RBI). A number of independent variables, including the lagged variants of some of them, have been used to perform the multivariate regression. Proper segregation of data has also been done to account for the impact of the major economic event of November 2016 namely ‘demonetisation of higher denomination currency notes’ in India.
Findings: Though this study finds that, barring the highly ineffective Benchmark Prime Lending Rate (BPLR) system, a significant progress has been made by Reserve Bank of India (RBI) in monetary policy transmission first through Base Rate System and then through Marginal Cost of funds based Lending Rate (MCLR) System. However, this paper finds that India is not yet ready to adopt the external benchmarking of lending rates, as proposed by an internal study group of RBI in 2017, primarily due to following reasons (a) Volatility issue of the proposed benchmark rates; (b) Lack of volumes, depth and maturity making them susceptible to manipulation; (c) Infeasibility of linking liability side and unilateral linking of asset side may hit banks’ profitability badly; (d) Manipulation through spreads would still be possible; (e) Possibility of draconian centralization of powers in the hands of RBI may be dangerous for the economy; (f) Possibility of lobbying by banking industry to influence RBI cannot be ruled out; and (g) It would be against the spirit of liberalization.
Application: This paper not only attempts to give a perspective with respect to prevailing and proposed systems of monetary policy transmission, but also encourages further research, so as to facilitate better policy formulation by RBI, which is evaluating all possible options, including external benchmarking of lending rates, in quest of perfecting the monetary policy transmission in India.