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Actual Monetary Transmission Mechanism in India: Impact Analysis

, July 23, 2019, 0 Comments

The Money Supply in the Country is impacted by several Interest Rates existing in the country. In this article we are exploring various terms and trying to understand what it means in the context of  Monetary Transmission Process.

The interest rates being primarily CRR (Cash Reserve Ratio, All Scheduled Commercial Banks have to deposit a certain portion of their Total Demand and Time Liabilities in the form of Cash with the RBI), SLR (All Scheduled Commercial Banks have to deposit a certain portion of their Total Demand and Time Liabilities in the form of gold, cash or other approved securities (Liquid Assets), with RBI), Repo Rate is the rate at which SCB’s borrow short-term money from RBI against Securities. Reverse Repo Rate is the rate at which banks park their surplus funds or excess liquidity with the RBI, Bank Rate is the rate at which RBI lends money to Commercial Banks. Bank Rate is a tool used for short-term purposes.

The Marginal Standing Facility is the rate at which commercial banks borrow from the central bank against their securities in the event of complete erosion of their liquidity position. Banks can even borrow from the RBI against their securities at a lower rate (repo rate, labelled under the liquidity adjustment facility). The difference between the two rates is based upon the liquidity situation, which a bank faces at any given time. Base Rate is the minimum rate beyond which banks do not lend to its customers. Call Money Market refers to inter-ban borrowing and lending on an overnight basis; Notice Money Market is inter-bank borrowing and lending for 2 days to 14 days; Term Money market is inter-bank borrowing and lending for 15 days to One Year.

The Monetary Transmission Mechanism impacts the country through  the following Transmission Mechanism further, It is explained here by underneath:-monetary-transmission-mechanism

Consumption is a part of Calculation of GDP by Expenditure Method. If  Consumption is increased, It increases the Income of the Country. The Inflation Rate is impacted by various interest rates as cited above. That impacts the Domestic Investment in the country. If Interest rates rise, Domestic Investment is reduced and vice Versa, There is a Crowding in /Crowding Out like Scenarios with Domestic Investment and Foreign Investment. The FDI/ FII impacts the Capital Account of Balance of Payments in the Country. This impacts the Volume of Exports and Imports of the Country via the Trade Balance Current Account. The Exchange Rate of the country is dependent on the respective changes in the Current Account, Capital Account and Foreign Exchange Reserves.

There is a second Monetary Transmission Mechanism specific to Indian Banking which is concluded from the Phd Research Thesis and is as follows:-

The following Banking Transmission Mechanism impacts the main Variable Net Interest Margins:

Bank Size as measured by Log of  Total Assets: Larger banks can operate with lower margins through scale efficiencies achieved. Larger the Bank Size, lower the Net Interest Margins and vice- versa.

High Non Performing Assets put pressure on the banks to increase the Net Interest Margins.

Non Interest Income: Greater the diversification banks achieve through fee -based

Activities, the more the banks can  tolerate lower Net Interest Margins.

GDP Growth Rates:Higher Growth Rates increase the Loan Demand and subsequently lead to higher Lending Rates or increased Margins

High CRAR:-Increased level of Capital Stability increases depositors’  confidence and also the availability of Low Cost Deposits for the bank

Inflation:-With increased inflation, banks   face a difficulty in deposit accumulation, and thus raise their deposit rate which eventually leads to lower Net Interest Margins

With the above  Monetary Transmission Mechanism in Banking, with Higher Growth Rates, Inflation Impact which is common to Banking, Monetary Transmission and also the first Transmission Mechanism, one can conclude, that GDP is  also dependant on Banking  and not just the other Macro Economic Variables impacting it.

If one is adept with the functioning of the Macro Economic Variables, and also the Banking Variables, their impact on the BOP Account also, one can foresee the impact of the same on Financial Variables from the micro analysis further.