MONETARY TRANSMISSION

Subject: Economy

Context : Banks with higher capital ratios transmit monetary policy actions more smoothly than banks with lower capital base according to recent study by RBI .

Concept :

• The RBI study attempts to understand the link between bank capital and monetary transmission by looking at the relationship between bank capital and loan growth/cost of funds.
• It states that for each one percentage point increase in CRAR, there is 7.8 percentage points rise in loan growth rate. On the contrary, one percentage point increase in GNPA ratio reduces the loan growth rate by 0.9 percentage points.
• In effect, while rise in capital ratio helps in better monetary policy transmission, significant amount of stressed assets could limit credit supply.

What is monetary policy transmission?

• Repo rate is the interest rate that the RBI charges the banks when it lends them money.
• The banks’ lending rate is the interest rates that banks charge from customers when they take a loan.
• By cutting the repo rate, the RBI has been sending a signal to the rest of the banking system that the lending rates in the system should come down.
• This process of repo rate cuts leading to interest rate cuts across the banking system is called “monetary policy transmission”.