Bank rate lives to die another day

The last time it was tinkered with was in April 2003 when RBI pared it by 25 basis points (bps) to a three-decade low of 6%

After almost nine years, the Reserve Bank of India (RBI) last week changed the bank rate. It has been raised and realigned with the so-called marginal standing facility (MSF) rate. This is a technical adjustment to link it with RBIs current policy rate, the repo rate, the rate at which the central bank infuses liquidity into the system. It drains liquidity through reverse repo. Currently, the repo rate is 8.5% and the reverse repo rate is 7.5%. Banks are required to invest at least 24% of their deposits in government bonds and any excess bond holding can be offered as a collateral to borrow from RBI at 8.5%. When a bank doesnt have excess bonds to offer as a collateral, it can borrow from RBI at MSF rate up to 1% of deposits. The bank rate has been raised from 6% to 9.5%, the MSF rate. The bank rate is a benchmark rate for RBI to buy or rediscount bills of exchange or other commercial papers eligible for purchase but since the central bank has not been doing discounting or rediscounting, the bank rate has remained inactive. The last time it was tinkered with was in April 2003 when RBI pared it by 25 basis points (bps) to a three-decade low of 6%. One basis point is onehundredth of a percentage point. Former RBI governor C. Rangarajan had brought the bank rate to the centre stage in April 1997 as a signalling rate, and cut it by one percentage pointfrom 12% to 11%after a gap of six years. He linked all interest rates on RBI advances such as the export credit refinance facility, liquidity support to primary dealers, among others, to the bank rate. To make the bank rate as an ideal reference rate, Rangarajan also introduced a new refinance facility to enable banks to tide over temporary liquidity shortages. Rangarajans successor Bimal Jalan repositioned the bank rate as the real signalling rate on the lines of the US Federal Reserve rate and delinked it from all refinance rates. This is in conformity with the recommendations of the report of a panel on financial sector reforms, headed by former RBI governor M. Narasimham. Jalan was in favour of using the bank rate sparsely, and focus on other instruments like repo rates, etc., to send short-term interest-rate signals. In fact, to ensure a special status for the bank rate, RBI, in its April 1999 policy, had announced an interim liquidity adjustment facility (ILAF)a mechanism for injection and absorption of liquidity available with banks from time to time. The idea was to reposition the bank rate on the lines of the US Fed rate, and the repo rate similar to that of the discount rate. A combination of both was to direct the interest-rate movement but that never happened.

In its earlier avatar, bank rate was the refinance rate and used just like the repo rate nowto borrow money from RBI by offering government bonds as collateral. Subsequently, this was delinked from the refinance rate and was only used for the so-called ways and means advances to the central and state governments. In other words, it became the rate for government financing. At the same time, it was also a forward-looking statement on RBIs views on interest rates in the medium term while the repo rate was supposed to signal the short-term outlook on interest rates. In the US, the prime rate, which is always higher than the Fed rate, is the benchmark rate for all consumer and retail loans while the London inter-bank offered rate (Libor) is the reference point for all corporate loans. Similarly, in the UK, the Bank of Englands base rate is the benchmark rate for consumer and retail loans while Libor influences commercial loans. In India, neither the repo rate (when liquidity is tight) nor the reverse repo rate (when there is plenty of liquidity) is the sole signal rate for bank loans and many other factors, including cash reserve ratio (CRR), or the portion of deposits that banks need to keep with RBI, influence loan rates. Being the discount rate, the bank rate should technically be higher than the policy repo rate but it took nine years for RBI to realize this. One wonders what prevents the Indian central bank from killing the bank rate as it has become irrelevant. Board nominee by stealth What is the connection between factoring and the number of government nominees on the RBI board? The government knows the answer. The lower House of Parliament in December passed the Factoring Regulation Bill 2011 to address the problems of small and medium enterprises (SMEs) who get their payment with a delay from large organizations and suffer from working capital shortage. Factoringor getting funds by selling receivables to a factor at a discountis an accepted business practice by some banks but there is no comprehensive legislation on this. Once the draft legislation becomes a law, banks will be able to lend to SMEs, based on the invoices of the larger companies where the SMEs have sold their goods and services. Basically, the banks will lend against the creditworthiness of the larger firms to whom the SMEs sell goods and wont check the creditworthiness of the SMEs taking loans. The Bill has quietly inserted a clause, suggesting amendment to the RBI Act and two government nominees on the central banks board instead of one. Currently, only the finance secretary is on the RBI board and he does not have any voting rights. Possibly, with banks getting into factoring in a big way, RBI will have a lot of work and the government is convinced that one more nominee on the board will help the regulator in doing so, but I wonder why the government needs to do this by stealth. Tamal Bandyopadhyay keeps a close eye on all things banking from his perch asMints deputy managing editor in Mumbai. Email your comments to bankerstrust@livemint.com. Also Read | Tamal Bandyopadhyays earlier columns