Monetary Policy Committee Notifications

[op-ed snap] The capital adequacy norms for banks could do with revision


From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Problems with monetary policy transmission


The monetary policy committee of RBI will announce its monetary policy decision. RBI is widely expected to cut rates.

Challenges in Monetary policy transmission

  1. Irrespective of the magnitude of a rate cut, the question of transmission is a big one.
  2. Interest rate cuts take much longer to be passed on.
  3. It is not even clear if interest rates matter in the current uncertain environment. 

Risk weights

  1. In the credit boom years up to 2007, RBI had proactively adjusted risk weights to dissuade banks from lending excessively to certain sectors and businesses.

Why reverse now

  1. According to data published by the Bank for International Settlements (BIS), India’s credit-to-GDP gap has been negative since 2013 and is now running well below trend.
  2. Banks are unwilling to lend and businesses are not keen to borrow either. The caution of banks should not starve creditworthy borrowers.
  3. In the post-2008 phase, regulators around the world have embraced counter-cyclical capital buffers and macroprudential norms to better regulate credit creation while interest rates hit new lows. RBI could use the mechanism of countercyclical capital buffers to ease credit conditions.
  4. Act in concert with owners of banks in enforcing lending discipline.
  5. Central bank prescribing the MCLR-based lending rate as the floor in a liberalized interest rate environment is incongruous.
  6. The government must use the crisis to legally enshrine non-interference in the operational decisions of banks
  7. The government must incentivize banks to augment their assessment of creditworthiness and risk assessment of loans on a continuous basis.
  8. Capitalization support and operational autonomy must be made contingent on skill up-gradation and other quantifiable performance measures.
  9. As economic conditions normalize, countercyclical capital buffers must and will move in the opposite direction.
  10. The bigger question is whether the capital adequacy norms prescribed under Basel III should be made uniformly applicable to all banks in India or only to internationally active banks. It will not only reduce the capitalization burden on the government but will also free up lending capacity.
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