The establishment of the link between deposit rates and the bank rate is a major development. In the past, the bank rate has not been utilised for any meaningful purpose. The Reserve Bank has recognised the power of this monetary tool as a benchmark rate and is expected to signal changes in inflation, liquidity etc. In future, by changing the Bank Rate Entities, the financial markets will be forced to think in terms of interest rate relative to this benchmark rate, rather than using fixed rates which were meaningless in a liberalising financial market that was subjected to volatility on almost every parameter.
While it is desirable to have a market-determined benchmark like Libor, the bank rate could be very useful in the interim period.
The operational freedom of banks and the banking system itself was constrained due to measures such as consortium financing, MPBF etc, which were often major irritants in establishing mutually beneficial commercial relationships between banks and their constituents.
The removal/dilution of measures related to such issues is likely to increase the flow of credit from banks to corporates, particularly corporates with higher credit ratings. While banks have now been permitted to evolve their own method of assessing the working capital requirements of borrowers, the apex bank has continued with the prescribed prudential guidelines and exposure norms. However, banks will have to quickly move to processes followed in international banking environment, where lending is based more on the balance sheet strength of the borrower, rather than comfort with short-term assets.
The corporate sector is likely to benefit considerably from the monetary policy. The increased operational freedom provided to the banks may result in quicker credit disbursals at rates linked to the bank rate. Non-bank finance companies can obtain higher credit from the banking system than in the past. This is a welcome step at a time when the sector is going through difficulty in acquiring long-term resources at competitive rates.
