|
On July 29, 2008, the Reserve Bank of India (RBI) raised
the repurchase (Repo) rate by 50 basis points to a seven-year
high of 9% to curb inflation, which was running close to
12%, and to dampen inflationary expectations. RBI also raised
the Cash Reserve Ratio (CRR)—the proportion of funds
that banks must keep on deposit with it—by 25 basis
points to 9%. The central bank left its reverse repo and
bank rates unchanged. The tone of the monetary policy was
extremely hawkish. Following the CRR and Repo rate hike
by the RBI, many banks have also revised their lending rates
upward (see table).
It would, of course, be interesting to explore the probable
impact of rising interest rates on bank loans and deposits.
In the past, rising interest rates were associated with
slower growth of bank loans and deposits. Furthermore, the
impact of rising interest rates on bank loans has depended
on the bank size and its volume of business, with smaller
banks typically suffering greater declines in loan growth
during periods of rising interest rates than larger banks.
To begin with, consider the effects of a retrenched monetary
policy that raises short-term interest rates; changes in
monetary policy can be transmitted to the real economy through
various channels. In the `credit channel', bank loans and
deposits play an integral and critical role, and interest
rate changes are transmitted to aggregate spending through
the balance sheets of banks and nonfinancial firms. Under
a contraction-based monetary policy, the central bank raises
the CRR and reduces the supply of reserves in the banking
system. Because certain deposit liabilities of banks are
subject to reserve requirements, a higher CRR and a smaller
supply of reserves can slowdown the growth of bank deposits.
|
