Indian public sector banks are not programmed to take risks and may well opt for treasury losses than go headlong into the corporate bond market.
If there is one thing that the Reserve Bank of India cannot be accused of, it is of not constituting committees that produce reports. So in keeping with form, and perhaps also as a way of giving the boys something to do while the grownups play bridge, it has set up a Working Group to review the current operating procedure of monetary policy, including the liquidity adjustment facility (LAF). The Indian Banks' Association (IBA) and the Fixed Income Money Market and Derivatives Association of India (FIMMDA) are invited too, as also external experts. The terms of reference are quite extensive but essentially designed to suggest ways of reforming the width of the LAF corridor and the frequency and timing of auctions. The Group will also examine international practice and tell us if there should be a corridor at all; if yes, it's width; if not, what then? It is more than likely that the Group will recommend that the incentive to banks to do overnight business with the RBI be reduced or eliminated, either by suggesting a zero differential between the repo and reverse repo rate or a differential that is so small as to not matter. Should this happen, banks will have no option but to turn to someone else for their nightly comfort. One of the likely candidates would be the corporate bond market which both the RBI and the Government have been trying to ignite — so far without much success. But if the safe haven that the RBI provides is withdrawn, the banks will have to take their chances in the wicked world of corporate bonds. Clearly, some very powerful people have decided that, to use an evocative Hindi phrase, “ laaton ke bhoot baton se nahin mantey.”(Those who only respond to force will not be open to persuasion.)
It might be too early to say what will happen but the chances are that, as with previous attempts at firing up the corporate bond market, this one, too, will fail if there is no system of insurance and re-insurance. Indian public sector banks are not genetically programmed to take risks and, given the uncertain ethics that prevail in the private sector, they may well opt for treasury losses than go headlong into the corporate bond market. Even a repo for corporate bonds will not be enough.
The RBI has also said that the Group will suggest ways of making monetary signalling more effective. This is a laudable objective but monetary signalling depends crucially on how much of the money market is above the line and how much is below. The volume of black money and other distortions in the price-setting system for money — interest rates on small savings, for example — all blur the semaphore flags that the Governor waves from the deck. The fault lies not with the signaller or the system of signalling but with the intended recipients.
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