2.9.3. Some Recent Terms

Quantitative Easing: This term is used to describe a situation or a form of monetary policy used to simulate an economy when the interest rates are very low or zero. It is an occasionally used monetary policy, which is adopted by the government to increase money supply in the economy in order to further increase lending by commercial banks and spending by consumers. The central bank infuses a pre-determined quantity of money into the economy by buying financial assets from commercial banks and private entities. This leads to an increase in banks' reserves.

Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates. Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central bank's only option is to pump money into the economy directly. That is quantitative easing (QE).

Quantitative easing comes with its own risks such as Inflation and depreciation of currency (Note: Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes).

Inflation occurs because with more money in economy, the cost of goods tends to rise. Depreciation can occur because with more currency in supply, one can buy less foreign bonds thus reducing the value of domestic currency.

It was first tried by the central bank of Japan to get it out of a period of deflation following its asset bubble collapse in the 1990s. The US government has done this three times so far. QE1 (November 2008 to March of 2010), QE2 (November to June 2011) and QE3 (September 2012 - October 2014). The US QE programme eventually saw a reduction (tapering) during QE3 and purchases of bonds were halted in October 2014. Federal Reserve Chairwoman Janet Yellen in 2017 has remarked that QE was a very unusual intervention which will not be frequently relied on in future as it causes fluctuations in the balance sheet of the central bank. Former RBI governor Raghuram Rajan has also questioned the use QE by developed countries to spur growth at home due to its implications on developing economies.

Marginal Standing Facility: Marginal Standing Facility (MSF) rate refers to the rate at which the scheduled banks can borrow funds overnight from RBI against government securities. MSF is a very short term borrowing scheme for scheduled commercial banks. Banks may borrow funds through MSF during severe cash shortage or acute shortage of liquidity.

Banks often face liquidity shortfalls due to mismatch in their deposit and loan portfolios. These are usually very short term and banks can borrow from RBI for one-day period by offering dated government securities.

The MSF is the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging through government securities, which has lower rate (i.e. repo rate) of interest in comparison with the MSF. The MSF would be a penal rate for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio. The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system. MSF rate automatically adjusts to 1 per cent above the repo rate.

Base Rate: Base Rate is the interest rate below which Scheduled Commercial Banks (SCBs) cannot lend to their customers. This rate was introduced in 2010 based on the recommendation of Deepak Mohanty Committee.

It was brought in to ensure that corporate houses are not lent money at low rates and Small and Medium business are not discriminated against with higher loan rates. In past banks used to compensate for lower rates for corporates by charging exorbitantly higher rates from Small and Medium Businesses (SMBs).

One another benefit of Base Rate is that it helps in monetary transmission, i.e. rate reductions undertaken by RBI passes through to all the sections of the society. In absence of such a regime corporate houses get the reduction and SMBs continue to pay higher rates.

This system has replaced the much abused Benchmark Prime Lending Rate (BPLR). The BPLR system, introduced in 2003, fell short of its original objective of bringing transparency to lending rates.

Base rate is determined on the basis of a bank’s costs of funds which include costs of deposits,

profit margins, operating expenses, administrative expenses and statutory expenses. Now, all categories of loans are priced with reference to the Base Rate only, except:

a) Differential rate of Interest (DRI) loans

b) Loans to banks’ own employees, and

c) Loans to banks’ depositors against their own deposits.

Since the Base Rate will be the minimum rate for all loans banks are not permitted to resort to any lending below this rate- accordingly, the provision of lending below the BPLR to a customer by banks if the loan amount is not less than Rs. 2 lakh has been withdrawn.