Rate cuts imposed on all banks isn’t the right move for the moment...
RBI has never been so active before, and it is this very enthusiasm that unquestionably highlights the severity of the financial crisis that is becoming more visible in the country, every passing day. With a slew of measures including the 350 basis points (bps) slash in the Cash Reserve Ratio (CRR), reduction in the Statutory Liquidity Ratio (SLR) by 100 bps et al, it has been successful in infusing enough capital into the financial system, thereby bringing about an unprecedented change in the dynamics of the banking business. Banks on the behest of the FM have readily agreed to slash the interest rates by 75 bps and this raises an extremely pertinent question – should bankers have the first say on interest rates or should the ministers and bureaucrats?! True that with improved liquidity condition and rate cuts, the confidence in the banking system can be shored up, but excessive loosening could also boomerang by igniting fears about the soundness of the economy and fundamentals of the financial system.
It is also true that higher lending rates dent the borrowers’ abilities to repay and the probability of default rises, but providing money at lower interest rates (thereby decreasing the risk spread) could very well hurt the profitability of the banks. As a warning, Sherman Chen, Economist, Moody’s Economy puts his fears in words as, “Cutting rates now and rapid capital outflows could lead to disastrous outcomes such as a further tumble in the stock market and a deep depreciation of the domestic currency.”
RBI has never been so active before, and it is this very enthusiasm that unquestionably highlights the severity of the financial crisis that is becoming more visible in the country, every passing day. With a slew of measures including the 350 basis points (bps) slash in the Cash Reserve Ratio (CRR), reduction in the Statutory Liquidity Ratio (SLR) by 100 bps et al, it has been successful in infusing enough capital into the financial system, thereby bringing about an unprecedented change in the dynamics of the banking business. Banks on the behest of the FM have readily agreed to slash the interest rates by 75 bps and this raises an extremely pertinent question – should bankers have the first say on interest rates or should the ministers and bureaucrats?! True that with improved liquidity condition and rate cuts, the confidence in the banking system can be shored up, but excessive loosening could also boomerang by igniting fears about the soundness of the economy and fundamentals of the financial system.
It is also true that higher lending rates dent the borrowers’ abilities to repay and the probability of default rises, but providing money at lower interest rates (thereby decreasing the risk spread) could very well hurt the profitability of the banks. As a warning, Sherman Chen, Economist, Moody’s Economy puts his fears in words as, “Cutting rates now and rapid capital outflows could lead to disastrous outcomes such as a further tumble in the stock market and a deep depreciation of the domestic currency.”
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
and Arindam Chaudhuri (Renowned Management Guru and Economist).
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