Reserve Bank of India (RBI) Deputy Governor Michael Patra on Thursday said financial inclusion results in better monetary policy transmission.
“Financial inclusion is found to improve the transmission of interest rate-based monetary policy impulses in two ways,” he said.
“First, the financially excluded would typically prefer ‘inside the pillow’ savings and for this, cash is the preferred instrument. As inclusion increases, their preference shifts from cash to interest-bearing bank deposits and other financial assets,” Patra said while speaking at an event organised at Indian Institute of Management (IIM), Ahmedabad.
Consequently, the interest sensitivity of financial savings in the economy goes up, he said. In view of compositional changes due to interest-bearing deposits replacing currency in people’s portfolios, the interest rate sensitivity of money balances also goes up. “Second, financial inclusion is expected to expand the access to bank credit, which is interest sensitive and affected by changes in the policy rate,” he said.
Interest rate sensitivity of money balances
In view of compositional changes due to interest-bearing deposits replacing currency in people’s portfolios, the interest rate sensitivity of money balances also goes up. The RBI moved away from regulating interest rates in the 1990s. This was followed by guideline-based loan pricing norms — prime lending rates; base rates; marginal cost of funds-based lending rates.
“All in all, financial inclusion enhances the potency of interest-rate based monetary policy by causing an increasing number of people to become responsive to interest rate cycles,” Patra said. In turn, this prompts appropriate smoothing behaviour. There is also some evidence to suggest that as interest rate sensitivity of the population increases, central banks need to move interest rates by less to achieve their objectives, he said.
“In India, the growing involvement of people in the monetary policy process has led to more democratic approaches to interest rate setting,” he said. The RBI moved away from regulating interest rates during the 1990s. This was followed by guideline-based loan pricing norms – prime lending rates; base rates; marginal cost of funds-based lending rates.
“The goal is transparency, customer protection and awareness, and being as market-based as feasible, all of which are intended to foster inclusiveness. Across these regimes, transmission of policy rate changes to both deposit and lending rates has improved,” Patra said. “The process has come full circle with the external benchmark-based lending rates — applied first to retail loans and credit to micro and small units — under which transmission is even fuller.”