RBI wants banks to cut lending rates before another rate cut

In order to improve the efficiency of monetary policy transmission, the Reserve Bank of India (RBI) Governor Raghuram Rajan on Tuesday said the RBI will encourage banks to move in a time-bound manner to marginal-cost-of-funds-based determination of their base rate.

While keeping the repo rate unchanged at 7.50 per cent, Rajan said the detailed guidelines will be issued shortly.

In fact, one of the reasons for maintaining status quo in policy rates was banks' reluctance to transfer to the consumer the previous 50 basis points rate cut since January this year. "The Reserve Bank will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates," said RBI.

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RBI had introduced the Base Rate policy in July 2010 where banks were allowed to set their actual lending rates on loans and advances with reference to the base rate. Currently, banks calculate their base rate based on average cost of funds and marginal cost of funds or blended cost of funds (liabilities).

"Base rates based on marginal cost of funds should be more sensitive to changes in the policy rates," says RBI in its first bi-monthly review of monetary policy.

In a media meet in Mumbai on Tuesday, Rajan, making a case for rate cut by banks, said: "The marginal cost of funding has fallen for banks. There is plenty of liquidity in the market. The credit growth is also tepid."

"If it (rate cut) happens sooner, better for the economy. But banks have to take their own decision," he added.