rbi-as-the-lender-of-first-resort

Context: RBI’s monetary easing tools are turning blunt even as the government relies on lending for an economic revival. Perhaps RBI could fight credit-risk aversion by buying corporate bonds.

Current scenario:

  • To ease credit in the economy: We have by now got accustomed to the Reserve Bank of India (RBI) declaring interest rate cuts in unscheduled instalments of monetary policy. 
  • Repo rate  was reduced to 4% last week, the lowest in about two decades.However, not all of this easing translates into cheaper or easier loans for borrowers.
  • RBI has slashed its reverse repo rate drastically too.
  • Ever since the covid crisis struck, our central bank has adopted a flurry of unconventional measures as well, mostly meant to put large tranches of money at the disposal of the banking system for disbursal or deployment. 

Rationale behind such move:

  • Rising default risk, given the current recession, plays a major role in money being less easily available.
  • Burden on Banks: Rising NPAs is another reason for banks to worry.
  • Slowdown: business demand for credit is held back by economic uncertainty.This is evident in the record sums that lenders have been lending RBI overnight via its reverse repo window. 
  • RBI has slashed its reverse repo: to dissuade the inflow coming through reverse repo rate but has no remarkable impact.
  • Big restraint on credit is not the cost of funds, but the fear that any debt advanced or taken would not be able to justify itself. 
    • A small business may not expect a return on investment higher than the interest rate on offer, for example, while a household may not see earnings rise to lighten the burden.
    • Most companies seem to have dealt with the crisis by cutting costs, not adding on debt.
  • In a nutshell a lack of market demand, revenue losses and doubts about servicing loans have joined forces to push money into safety vaults at a time it needs to get out there and move around.

What should be done?

  • A burst of government spending is the need of the hour.
  • RBI needs to take a relatively radical approach:  It could take this risk upon itself by buying corporate bonds. 
  • If RBI cannot directly subscribe to debt issuances by India Inc. or snap up its debentures in the secondary market—since its choices would draw scrutiny—it could still ease the flow of credit to companies by opening a repo-like window for the purchase of well-rated corporate bonds from banks, which are reported to be investing heavily in these. 

Repo Rate

  • It is the rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds (Reserve Bank of India, in case of India).
  • It is used by monetary authorities to control inflation.
  • In the event of inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
  • The central bank takes the contrary position in the event of a fall in inflationary pressures.
  • Ideally, a low repo rate should translate into low-cost loans for the general masses. When the RBI slashes its repo rate, it expects the banks to lower their interest rates charged on loans.

Reverse Repo Rate

  • Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. 
  • It is a monetary policy instrument which can be used to control the money supply in the country

CRR- Cash Reserve Ratio

  • Banks are required to hold a certain proportion of their deposits in the form of cash. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR.
  • It means that banks do not have access to that much amount for any economic activity or commercial activity.
  • Banks can’t lend the money to corporates or individual borrowers, banks can’t use that money for investment purposes. CRR remains in the current account and banks don’t earn anything on that.

Corporate Bond

  • A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it needs and in return the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate.
  • When the bond expires, or "reaches maturity," the payments cease and the original investment is returned.
  • The highest quality (and safest, lower yielding) bonds are commonly referred to as "Triple-A" bonds, while the least creditworthy are termed "junk".


Source: https://www.livemint.com/opinion/online-views/why-rbi-should-now-be-our-lender-of-first-resort-11590513462947.html

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