Rise in credit may not always find its way towards increasing investments: RBI paper

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January 05, 2021 10:56 PM

The paper further says that banks respond to changes in money market spreads faster and better than changes in policy rates, which are announced by the RBI bi-monthly.

The paper uses a unique rm-bank matched dataset from India to provide new insights into the monetary policy transmission mechanism.The paper uses a unique rm-bank matched dataset from India to provide new insights into the monetary policy transmission mechanism.

An increase in credit may not always find its way towards investments as business entities may use credit lines to finance their current liabilities, a Reserve Bank paper said on Tuesday.

The paper further says that banks respond to changes in money market spreads faster and better than changes in policy rates, which are announced by the RBI bi-monthly.

“…in addition to slow or lagged monetary policy transmission, an increase in credit may not always find its way towards increasing investments. Firms may use their credit lines to finance their current liabilities rather than undertaking capital formation,” said the paper written by Saurabh Ghosh and Abhinav Narayanan, both officials of the Reserve Bank of India (RBI).

Monetary policy transmission has remained a pivotal topic of interest across all central bankers. Empirically, however, it is hard to disentangle the effects of a policy change on firms’ investment demand, banks’ credit supply and their interactions.

The paper uses a unique rm-bank matched dataset from India to provide new insights into the monetary policy transmission mechanism.

The findings of the paper indicate that monetary policy transmission works with a lag for bank lending. For firms, aggregate demand conditions in the market may drive investment demand which may, in turn, be correlated with the monetary policy easing cycle.

However, final credit flows from banks depend on the liquidity position of banks that the firms are attached to. These findings indicate the importance of banks’ liquidity in addition to the balance sheet channel for improving the efficacy of monetary policy transmission.

The central bank said the views expressed in these papers are those of authors and not of the RBI.

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