RBI Market Operations Assisted Banks in Funding During the Pandemic

The Reserve Bank of India’s (RBI) market operations aided banks in balancing the financing requirements of several sectors of the economy during the pandemic. RBI published a study related to this on Thursday. RBI’s working paper titled ‘Banks’ Credit and Investment Dynamics: Assessing Portfolio Rebalancing and Crowding-out’ inspects the asset portfolio dynamics concerning Indian banks and the effect of their investment in Government Securities (G-secs) with regard to their profitability. The study mentioned that in 2020-21, the COVID-19 pandemic resulted in a sharp loss of output.

RBI Working Papers series was introduced in March 2011. RBI mentioned that the views recorded in the papers are of the authors and not of the institution(s) they work for.

The analysis also indicated that weak economic position and stressed asset quality motivate banks to expand their investments in G-secs, recommending a portfolio rebalancing channel. When banks invest in government securities and increase their borrowings from the central bank, it crowds out private credit and substantially affects banks with high non-performing loans. However, during periods of stronger economic growth, this effect is lessened.

As per the empirical analysis, both crowding-out channels and portfolio rebalancing played a role in the banks’ credit decisions. Policies aimed at strengthening the asset quality and the capital position of the banks could result in an increased flow of bank credit to the productive sectors. RBI’s proactive monetary, liquidity and regulatory measures made sure continued credit flows not just via banks but also via market instruments such as corporate bonds helping to revive economic activity.

The paper emphasises the importance of aligning the policy interventions with the economy’s production structure to reap maximum benefits.

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