More Teeth For Bank Rate Likely; General Refinance Facility May

The Reserve Bank plans to give more teeth to bank rate as a policy instrument. The rate currently relies on the mandatory link to the deposit rate to control the interest rates. Bankers feel that the Reserve Bank might bring in a liquidity adjustment facility (LAF) in place of the general refinance facility of Rs 4,600 crore.

It is pointed out that if the deposit rates are deregulated, the signal will be strong enough to send interest rate impulses into the banking system. The Reserve Bank in its annual report for 1996-97 has stated that the efficacy of the bank rate as a policy instrument depends essentially on the dependence on the RBI for funds and the influence it wields on other interest rates.

 

Since, the funds provided at the bank rate is just Rs 4600 bankers feel that it will not be very effective. That apart the bank specific refinance facility does leads to funds moving in or out of the system.

Under the LAF, liquidity adjustment is proposed to be provided through Primary Dealers (PDs) by way of repos and reverse repos. This enables liquidity to be sucked out from where it exists and provided where it is needed rather than a general draining out or injection of liquidity under the present system. For instance, a cash rich bank can do a reverse repo with a primary dealer, who in turn can do a repo with a cash strapped bank. Hence, there will some support from the Reserve Bank under the LAF, but the system itself will transfer funds from liquid pockets to dry pockets.

Banking experts point out that LAF will deepen the secondary market in Government securities, enable the development of a smooth yield curve, mitigate interest rate volatility and strengthen the primary dealer network. It is felt that the governors who in all probability will be announcing the his last monetary policy will finally make the bank rate the most powerful tool of monetary control. Rangarajan has been advocating for the a strong bank rate as a signalling mechanism for quite a few years and is expected to strengthen it in his last monetary policy.

A strong signal rate is a prerequisite to deposit rate deregulation.