Abolition of MPBF does not leave a vacuum in the system

/ BSCAL April 17,1997

Despite the prevailing political uncertainty at the Centre, the monetary and credit policy for the first half of the financial year 1997-98 unveiled by the central bank on Tuesday has initiated a series of steps like reactivating the Bank Rate and giving banks more freedom by doing away with MPBF and consortium lending. In an interwiew with Business Standard, Reserve Bank governor C Rangarajan said his only concern while formulating the policy was whether the financial sector was ready to absorb the reforms. Excerpts: Could you elaborate on the factors that prompted you to come out with such a bold policy ?
Click here to visit SME Buzz

We felt that the banking sector was ready to take on the responsibility. There were certain reforms that had to be put in place first, before certain other steps. We thought that with banks having adequately provided for the backlog of bad and doubtful assets in line with prudential norms and exposure limits, the time has come for banks to be given freedom on a number of issues that were being decided by the Reserve Bank of India. In that sense it is a continuation of the banking sector reforms, but it is also an important development as conditions have now been created for banks to take on this responsibility. Was the political scenario an opportunity or a burden? The basic consideration that went into deciding whether this was an appropriate time for these changes was whether the financial sector was ready to absorb these decisions. I believe the banks were ready. How effective will be the new Bank Rate? The Bank Rate must perform two functions -- as a reference rate as well as a signal rate. As a signal rate, it must be an indicator of the stance of monetary policy. As a reference rate, it must become operationally significant. We have been providing refinance so far at a rate which was different from the Bank Rate, so the significance of the Bank Rate was not there. In the monetary policy, we have made the Bank Rate operationally significant by providing refinance at the new Bank Rate. Now that all other rates are linked to the Bank Rate, it could be moved upwards or downwards to send signals to the rest of the financial sector for re-aligning the other rates. But merely having a Bank Rate is not enough. The Federal Reserve of the US, for instance, follows up a rate cut by conducting open-market operations to achieve a particular objective. So, while we can adjust the Bank Rate, we must use other instruments like open-market operations to achieve the particular goal we have in mind. As commercial banks adjust lending and deposit rates in relation to the Bank Rate to an extent, it will become significant as a reference rate. I think it is possible to move in that direction when changes in the Bank Rate works as an indicator of the central bank's stance on monetary policy. What will be the effect of linking all refinance to the Bank Rate? Whether it is a general refinance facility or a sector-specific refinance limit, it is quite clear that all these will have to be linked to the Bank Rate. By making the refinance facility more or less costly, you can have some impact on the banks. But what is important is that regardless of whether refinance is a general facility or a sector-specific one, there is no doubt that this will have be linked to the Bank Rate. What about the steps taken to deepen the markets and make them more vibrant? The standing advisory committee on the money market has been created to give constant advice to the Reserve Bank about ways in which money market can be further developed.

We have standing committees for many such areas like SSI (small-scale industries) credit, urban co-operative banks and so on and it was felt that such a committee will help develop the market further. But we have not finalised the composition yet. Are you afraid that the move to scrap MPBF may backfire? I don't think there is any chance of the scrapping of the MPBF backfiring. We have said that banks need not necessarily follow the rules laid by the Reserve Bank of India. We have given them the freedom to use the same norms but with a few modifications or devise their own alternative plans. So, there is no vacuum being created. If anything, banks have been told clearly that until they formulate a well-planned alternative, the present system will continue. What we are asking the banks is what would be the best method for evaluating the working capital needs, and their boards will have to lay down the guidelines. The banks, then will have to follow the norms. This will enable banks to experiment with new tools for delivering credit. The correct signal is that the delivery system has to be improved to sustain a larger flow. This is because their lendable resources have increased as reserve requirements have come down. Banks have to find ways and means of increasing the flow of credit without exposing themselves to undesirable consequences. Therefore credit planning, for instance, takes on a different hue. Earlier, credit planning played no major role because the available resources was limited. Now, they have to ensure that whatever resources are available have to be productively employed. Couldn't participation in the money market have been extended to other financial intermediaries like NBFCs and mutual funds? First of all, to learn lessons from the past, we must have a system of delivery versus payment. Therefore, as of now, we want to restrict it to only the SGL (subsidiary general ledger) account holders as there is a system which checks that delivery and payment occur at the same time. We have taken the initial steps to expand the money markets. For example, repos have been allowed across their entire range of government securities. Besides, non-bank SGL account holders have also been allowed into reverse repos. After we see that a system is established, we can decide whether non-bank entities can be allowed to do repos as well, along with reverse repos. Will you consider extending the gamut of instruments eligible for repos to include PSU bonds? Well, in terms of instrument, we have to be sure that there is a mechanism by which delivery and payment can take place simultaneously. So far, we don't have such a mechanism either for units or for PSU bonds. Later on, perhaps after the depository system takes root, one can look at expanding the range of instruments. Apart from the scrapping of consortium lending and MPBF, you have also given the corporates more flexibility in raising and deploying money in the short-term. Was there a specific demand? The moment you move away from cash credit to a loan system, there is a need for corporates to have appropriate investment avenues to deploy surpluses, as their needs vary over time. That is why we brought down the minimum level for certificates of deposit, for example, to give corporates an additional avenue to deploy short-term surpluses. The same logic also applies to reducing the tenure for CPs (commercial paper) to 30 days as they need funds for different maturities. Are the changes in the forex market to prepare the players for full convertibility? Some of the steps are in the direction to provide a greater ease in dealing with foreign exchange transactions. These are not directly related to full capital account convertibility. But certainly, the decision to let authorised dealers borrow and invest up to $10 million in foreign markets is a relaxation in capital transactions but will apply only to the banks. So it is a move in that direction. But the decision to allow forward contracts on the basis of future projections was made because there was a need for certain people to have forward covers beyond 180 days. While there was a demand, there was no identifiable source of supply for forward covers beyond 180 days. Therefore, we have said that banks can sell forward covers to regular exporters and, in effect, create a market where there would be supply of funds for periods beyond 180 days. That was the motivation behind this move.

Do you expect an outflow on NRE deposits after the rates were brought down? What we are trying to do is to bring the NRE deposits almost on par with domestic deposits. Earlier, the rate was fixed for two years and banks were free to decide beyond that. But in the domestic market, they had already been given the freedom to fix rates beyond one year. So, this exercise was to rationalise the two interest rate structures. We also took a view on what the appropriate rates should be on NRE deposits and decided to bring it down to the levels of the domestic interest rates. Is it a pointer for the future ? We hope that there should be some linkage and similarity between all term deposit rates and the NRI deposit rates. Why re-impose CRR (cash reserve ratio) on NRI deposits? Does this indicate that such deposits may not be all that welcome in the banking sector? We have taken a view that hereafter all liabilities to the public should attract some reserve requirements. In fact, we have made a concession by saying that only incremental deposits would attract CRR rather than the stock of NRI deposits. This was done because it was felt that portfolio judgements would have been made and allocations would have been made by banks on the assumption that it does not attract CRR. Now, suddenly to say the entire stock would attract reserves would have upset these calculations. Therefore, we decided to apply reserve requirements on the incremental deposits and bring them on par with the domestic ones. Please also note that all NRI deposits have been treated equally, unlike earlier when some had low reserve requirements and other higher. What was the rationale behind allowing banks to make loans against shares? The reason for this particular measure stems from the fact that the capital market has not been buoyant. And, in the absence of any equity being raised, this also had an impact on the levels of working capital demand. Therefore, we tried to find a way where the banks could be given some amount of support to the capital market. But this is not a bridge loan. Here, loans will be given against pledge of securities and should enable corporates to invest in equity. All the refinance will have to be linked to the Bank Rate. By making the refinance facility more or less costly, you can have some impact on the banks The basic concern that went into deciding whether this was an appropriate time for these changes was whether the financial sector was ready to absorb these decisions. I believe the banks were ready We have made the Bank Rate operationally significant by providing refinance at the new Bank Rate. Now that all other rates are linked to the Bank Rate, it could be moved upwards or downwards to send signals to the rest of the financial sector. The reason for allowing loans against stocks stems from the fact that the capital market has not been buoyant. And, in the absence of any equity being raised, this also had an impact on the levels of working capital.