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Experts want credit policy to bring FIs under RBI purview

The forthcoming credit policy of the Reserve Bank of India on October 30 is likely to address structural issues and focus more on strengthening of the financial system than on indicating any firm direction for interest rate movement over the rest of the year, according to financial analysts and investment bankers in Bombay.

Underlining the need for an effective monitoring system in view of the recent developments in global markets, analysts said that there was a need to broad-base the credit policy to get financial institutions firmly under the regulatory purview of the RBI. With the increase in market volatility and vulnerability to external shocks, use of risk management systems needs to be made mandatory for banks and financial institutions.

Another focus area for the credit policy would be tightening of provisioning requirements to reflect the true financial health of banks, they said.

On policy expectations, they said that a hike in prime lending rate and bank rate from the RBI was forthcoming. They added that the RBI may leave the cash reserve ratio unchanged.

In its weekly outlook on Indian markets, Morgan Guaranty Trust Company of J P Morgan said that the RBI would be worried about rising inflation and the recent spurt in money supply that would prevent any reduction in the CRR in spite of the fact that currency market uncertainties have subsided considerably in the past couple of months.

The prospects of a bank rate hike to bring it in line with other interest rates in the economy are quite high, it said.

Analyst Ashish Pitale observed that the bank rate had been conspicuously flat during the last six months when the benchmark of other interest rates like short- and medium-term yield of securities shot up by 100 to 200 basis points. The PLR is too low to justify the higher risk.

The cost of funds for banks has increased without a corresponding rise in their lending rates. The risk premium over sovereigns charged by banks to the corporate sector has actually declined particularly during the period of industrial slowdown and sharp declines in corporate profitability. This factor needs to be addressed urgently to ensure that bank lending rates reflect the higher risk differential between the sovereign and the corporate as compared to a year ago.

Ruling out any immediate cut in CRR, the J P Morgan report said that reducing CRR in the face of a steady increase in wholesale price inflation and spurt in money supply growth to 20 per cent would further fuel the expansionary pressures in the economy.

The credit policy is also unlikely to include any strong interest roll-back measures and could trigger an upward correction in long-term yields. The present PLR levels are at an artificially low and are no longer a meaningful indicator of the true borrowing costs.

On Indian rupee, the report felt that the currency was unlikely to weaken sharply as long as the RBI continued to enforce a strict control over the markets. However, the depressed export situation which had fallen with a net negative three per cent in the first four months coupled with bearish FIIs' sentiment on stock markets, could put the pressure back on the rupee.

Insisting on further tightening of capital adequacy norms, it said that the recent turmoil in global markets underlined the need for a sound financial system and hence tighter capital adequacy requirements for banks and financial institutions. A more prudent measure would be to assign a risk weight to banks' investments in government securities in excess of their SLR requirements -- particularly since these are market-view based positions taken voluntarily by banks.

Although such a move might serve as a disincentive for banks investments in gilts, it would be a major step towards increasing the awareness of the market risks associated with such investments, the Morgan report said.

UNI