4 Things RBI Can Do To Get Banks To Lend Immediately
The reverse repo (RR) rate, which is the interest rate that the Reserve Bank of India (RBI) pays the banks for parking their surplus funds with it, has seen two cuts since the 27th March. It came down from 4.90% to 4% as per RBI notification on the 27th March. It was further reduced from 4% to 3.75% on the 17th April. These cuts were meant to stimulate banks to deploy these surplus funds as investments and loans in various (productive) sectors of the Indian economy. 
But let see what has happened. The amount parked by the banks at the RBI reverse repo window was Rs6,99,312 crore on 17 April 2020, while the surplus parked by the banks at the RBI reverse repo window on 6 May 2020 increased to Rs8,53,282 crore. This clearly shows two things: a) banks are risk averse and unwilling to lend money; and b) demand is also muted.  
So, what can and should RBI do? 
One, RBI can further cut the reverse repo rate. I will stick my neck out and predict that this rate could come down to even 3.5% (or even lower) in the near short term. But I doubt if that will help as the data clearly shows a huge risk-aversion among the banks and I don’t blame them after what happened since 2008. 
Two, RBI can get bold and unconventional, as its governor has already remarked. It could cap funds that can be parked in the reverse repo window by banks. This will force banks to lend to some extent. There are advantages and disadvantages here but this again must come with a sunset clause as it will otherwise impact financial stability in the medium and long term.
Three, RBI could create a special purpose vehicle as the Fed has done in the United States and guarantee different classes of loans to be made by banks with differential rates of guarantee—this could range from 65% to 90%, depending on various factors. Of course, this will also have to come with a sunset clause and that is where the uncertainty with regard to COVID-19 really hampers decision-making. But all said and done, the need for underwriting loans to be made by banks and other FIs is huge and only the RBI can intervene in this matter and that too for a specified period of time. Otherwise, financial stability will again be threatened. 
Four, RBI could directly get the non-banking financial companies (NBFCs), micro finance institutions (MFIs) and alternative financial institutions (subject to certain conditions) to lend to the small and medium enterprises (SMEs) and to the poor and vulnerable people. More than ever, we need greater money in circulation in the economy. This again is unconventional and has to come with a sunset clause in the interest of financial stability. 
All said and done, RBI is an autonomous institution and it must act now to safeguard the economy. If companies become bankrupt and people do not survive this crisis, no amount of stimulus (at a later date) can help revive the already stumbling Indian economy. On its part, the government of India must fully support RBI and encourage it to make appropriate decisions immediately, in the larger interest and good of the country. 
Without a doubt, it is make-or-break time and I have been saying this for some time now. Failure to act now will mean a lower quality life for millions of our children and grand-children. Indeed, it is the RBI’s responsibility to act now and decisively to help mitigate the horrific impacts of the COVID-19 crisis on the Indian economy.  
One final point is in order. Let us bear in mind that finance alone cannot get the COVID-19 supply chains restarted or the demand kick-started. Thus, while measures to control the disease and its spread must continue at full speed, actions must also be simultaneously taken to alleviate liquidity problems and keep the firms, including SMEs and individuals, including the vulnerable poor, afloat. 
This liquidity and survival enhancing measure must be underwritten by RBI and/or the government of India. This money will not go waste. If firms go bankrupt or people with skill-sets cannot survive, it will be a huge irreversible loss. 
At the same time, expecting the demand and supply shocks to suddenly disappear is very naive, given the huge health, economic and other uncertainties around COVID-19. That said, overcoming the huge consumption shock and crisis that we are already facing again calls for bold and unconventional measures including radical reforms to taxation such as the swapping of all direct and indirect taxes with a variable banking transactions tax (which is a very viable option indeed) as I have alluded to elsewhere. 
That, however, is a call that only the government of India can make and let us hope that policy-makers make that bold unconventional decision as drastic situations call for radical measures. 
(Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years.)
1 year ago
Banks are scared of lending. They are afraid of lending, fearing NPAs will increase further. GOVT and RBI go on goading to lend more and more. If RBI further reduce reverse repo rate further, Banks deposit more and more in RBI, the safest investments. After all, the interest paid to depositors in SB and FDs is pittance by the banks. The deposits in RBI under "reverse repo rate" is mind boggling at Rs853282 crores which are lying idle in the coffers of RBI.
Such huge funds should be deployed for the progress of the nation.
1 year ago
Its time to be passive defensive rather then aggressive by putting bad money in systems Mahesh Bhatt
Replied to mahesh.bhatt comment 1 year ago
Many SMEs and corporations were going concerns and doing reasonably well before the COVID-19 CRISIS. Not enabling them to survive would be a huge mistake. Thanks for your comments and let us agree to disagree. I respect your views all the same but politely disagree.
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