Home >market >mark-to-market >Why RBI cut the marginal standing facility rate

Here’s why the Reserve Bank of India (RBI) brought down the interest rate on its marginal standing facility (MSF) on Monday.

Between 12 July (just before the central bank took the liquidity tightening measures to prop up the rupee) and 20 September, while the bank credit had gone up by 2.18 trillion, bank deposits had increased by a much lower 96,490 crore. In other words, the incremental credit to deposit ratio over the period was a huge 226.7%.

This was because of two reasons. One, companies preferred to borrow from banks because of the high rates prevailing in the money markets, and two, there was a pickup in bank credit as the busy season gets under way.

As the chart shows, banks’ overall credit to deposit ratio has crept up steadily, from 76.2% on 12 July to 78.3% on 20 September. There was, therefore, a crying need to lower money market rates and ease liquidity, which is precisely what the central bank did on Monday, taking advantage of the opportunity provided by the stable rupee and the likely deferring of the tapering of bond buying by the US Federal Reserve as a result of the fiscal impasse in that country.

How different is the credit to deposit ratio from what it normally is at this time of the year? On 21 September last year, it was at 75.7%, well below the 78.3% it was on 20 September 2013. Bank credit has gone up by 6.8% in the current fiscal year to 20 September, much more than the 3.3% rise over the same period last year.

This is an anomaly, as economic growth is now lower. In contrast, deposit growth this fiscal year to 20 September is 6.3%, compared with 6.5% in the year-earlier period. Hence the rising credit to deposit ratio.

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