The low sensitivity of bank lending rates to changes in key rate signals blunts the usefulness of India's monetary policy in spurring growth, the central bank said in its report on currency and finance.
To reduce rigidities in the interest rate structure, the Reserve Bank of India said it had encouraged banks to introduce flexible rates on deposits and announce a maximum spread for lending rates over the prime lending rate.
"In view of the weak sensitivity of bank lending rates to changes in the bank rate, the efficacy of the monetary policy in reinvigorating growth runs up against a constraint," the central bank said in a statement on Monday.
Between March 1998 and March 2003, the central bank has cut the bank rate by 425 basis points to the current 6.25 per cent.
The easing was mirrored by a general softening of rates in the money and government securities markets, but lending rates have remained fairly sticky.
The central bank said this inflexibility could be a result of banks' high average deposit cost, partly because of the lofty returns that alternative saving schemes offer.
Moreover, a substantial portion of long-term deposits offered fixed rates, which limited banks' flexibility in reducing lending rates in the short term.
The large proportion of bad loans also kept the cost of funds for high, and the possibility of default was higher now because of the economic slowdown, the central bank said.
The government's large borrowing programme also made it difficult for rates to fall, it said.
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