 Good evening. Good evening and welcome to this public lecture. May I invite the speaker, Dr. Viral Acharya, Prof. Deepan Ghosh, President of the TAA and Prof. Sandeep Trivedi, the Director to come on stage, please. Could you all move forward so that we can have a closer interaction with the speaker. And thank you once again. This is the first public lecture named the Abhiguha Memorial Lecture. The TFR Alumni Association, as many of you know, interacts with the public of Mumbai by organizing various lectures, bringing the alumni and the public at large together so that there is a fruitful interaction. And we can sort of catch up on what's going on in various spheres of life. So the public lectures are a major vehicle for this interaction. And the Alumni Association, unlike several other big institutions, the TFR Alumni Association has rather small numbers. But these are people who have had huge influence in various spheres of life. And many of these activities, particularly in the beginning of our independent India, started in this institution. And the alumni from that time and after that have gone on to carve great careers for themselves and serve the society in different ways. So without taking too much time, I invite our director, Prof. Sandeep Trivedi, to say a few words and then we will move on to the rest of the function. Dr. Acharya, Prof. Ghosh, Prof. Ravinder Kumar, distinguished colleagues, my dear friends, fellow students of all ages, a very good evening to you and welcome to this evening's lecture. The lecture is in honor of Mr. Avi Guha and has been endowed by his parents in memory of Mr. Avi Guha. Avi grew up here on campus. His father was a colleague of ours in TIFR before the family moved to the United States. Unfortunately, Mr. Avi Guha passed away a few years ago at a young age and his parents have endowed this lecture in his memory. So we thank the family for this endowment. It is an opportunity for us to remember Mr. Avi Guha and also to engage with the community at large in Mumbai and bring to you a very eminent speaker whose thoughts we can share and learn from and interact with. Indeed, today we are very privileged to have Dr. Acharya here with us. He is well known to be, if I can use the word, a whiz kid, a very brilliant person. I think we might hear a little more about that from Prof. Ghosh and we are all looking forward to his lecture this evening. I can't help but also recall another very impressive lecture we had in that case from the governor of the Reserve Bank of India about a year ago, Dr. Raghuram Rajan. It was a brilliant lecture. Those of you who were here for that lecture might recall and indeed a very timely one because I can't take any credit for it. But it was Dr. Rajan's first public engagement after his decision to return to the fold of academia. And indeed he put up a brilliant presentation of his ideas of inflation and so on, including monetary policies which he had taken forward at the RBI. And so we are especially looking forward to hearing Dr. Acharya also touch on some of those themes this evening. Once again, I welcome you all for this evening's lecture and those of you who are from outside of TIFR, I hope this is not your first time. But in any case, I hope it won't be the last time we see you here on campus. Thank you very much. So let me now invite Prof. Deepan Ghosh, President of the TIFR Alumni Association, to say a few words about the institution of this lecture, a little bit of background and then move on to introduce the speaker. Prof. Acharya, Prof. Trivedi, ladies and gentlemen. As has been told by Prof. Trivedi in his introduction, Avi Goa was son of Prof. Shubhendu and Jayashree Goa and he was actually born and as a child he played around in this campus in the TIFR colony. And I sort of remember him as a small child and Prof. Shubhendu Goa also happens to be a brother-in-law of Prof. Shukumar Biswas and which in Bombay English is called a co-brother of Prof. Shukumar Biswas. And as I said, Avi grew up at TIFR housing colony and the family moved to United States in 1982. Avi got his bachelor's degree in electrical engineering from University of Michigan and the MBA from Ross Business School of the same university. He worked for SAP Americas, Booze & Company and more recently at the time of his death at MJ Holding Company as the head of global strategy and investment. He was the founder of MBA Day Camp located in Chicago. Avi passed away last year on March 27th, leaving behind, he was the only child of his parents at the age of 42, leaving behind his parents, wife Jessica and two children. I take this opportunity of thanking Goa family for instituting this annual lecture in memory of their beloved son. And I hope we will continue to have distinguished speakers on this occasion every year. I will now introduce the speaker of today, Prof. Viral Acharya. When I informed this to Prof. Swendu Goa, who has instituted this award, he wrote to me, Computer scientist turned a financial guru, there cannot be a greater tribute to the memory of my son. When I tried to look up his bio-data on this website, it has 21 pages. So if I start reading his bio-data, I will be the main speaker today and not Prof. Acharya. I don't think you want me to do that. Actually speaking, I must tell you, many of you may not know, I mean, I am, though I am president of the TFR Alumni Association, my lifelong association other than for doing a PhD here has been with Indian Institute of Technology. And it is in that connection that I came to know Prof. Viral Acharya. Born in 1974, he joined IIT Bombay Computer Science and Engineering Department. In 1991 and graduated after four years in 1995. Now, I was just telling the director that he was, of course, the top graduate of that year, winning the president of India Gold Medal. But not only that, we have a second gold medal, which is not just for academic performance. It is for overall the all-rounder of that year. And that goes by the name of Shankar Dayal Sarma Gold Medal. And that also Prof. Viral Acharya won it that year. After that, he actually went to do the PhD in Computer Science to University of New York. But after a year or so, he thought his calling was in finance. I don't blame him for that. So he shifted in the same university to do a PhD in finance. And in 2001, he got a PhD. After 2001, he spent about eight years in London School of Business in various academic capacity, ending finally as the professor of finance in the same university. He then returned to his alma mater as a professor of finance at the Stern School of Business. He was offered the position of deputy governor of Reserve Bank of India in 2017, that is this year, and is presently on leave from his position as CV star professor of economics. Viral's primary research interest. I want to make this point clear. His name is Viral Acharya, not Viral Acharya. That is obviously would be wrong. Viral's primary research interest is in theoretical and empirical analysis of systemic risk of the financial sector. Its regulation and genesis in government introduced distortions and enquiry that cuts across several other strands of research. Credit risks, liquidity risks, their interactions and agency theoretic foundations, as well as general equilibrium consequences. Viral is the recipient of inaugural Bank de France Toulouse School of Economics junior prize in monetary economics and finance in 2011. And recently in 2017, I can't pronounce it properly, Alexander Laugh, maybe he can help me, Laugh Laugh's senior research fellowship in bank and international settlement. He has authored four books and has written numerous research publications. I can't tell you how many because his bio data doesn't give a serial number. When he was appointed deputy governor of Reserve Bank of India, I think it is live mint which wrote, the new deputy governor of RBI is not a boring banker as many would expect. Viral Acharya has been a rock star in his head. Apart from a stellar banking and teaching career, Acharya has also released his own album entitled Yadav Ke Silsile with at least 10 of his own compositions for it. As a founding member and chairman of Pratham UK and later Pratham USA, the UK chapter of Pratham, an Indian NGO providing pre-primary and primary education to underprivileged children in India, and in Britain they raised over 2 million pounds. As I started saying, Viral in Hindi means rare and Acharya of course as you know is a teacher. So ladies and gentlemen, it's a great pleasure for me to present a rare professor, Professor Viral Acharya. So before we hear an exciting lecture from the rare speaker that we have today, I invite Prof. Trivedi to formally welcome Prof. Acharya. So in the traditions of this auditorium, we thank the speaker for the wonderful lecture that he's going to give us. So let's join and welcome Prof. Acharya. Thank you everyone for staying back. I'm told that five o'clock is usually the time when TIFR shuts down and everyone heads out. Normally that's the time I wake up and sort of get going to do things outside of my day job like thinking about research or music or watching Roger Federer play or any of the various hobbies. So I want to first thank TIFR for inviting me and I'll start off on a personal note and then move over to what I want to talk about today. I'll try and keep it simple. I'm not sure if I have succeeded fully, but if I haven't, you can invite me again and I'll try and do it right next time. When I travel from my residence in Vileparla West to the Reserve Bank of India's central office in Fort, I pass each way, Kenilworth, the birthplace of late Homi Jahangir Baba. It's near Kemp's Corner as you pass Just Look Hospital. It is a good way to start and end the day being reminded not just of his immense intellect, but also of his deep sense of service to India. I'm thus grateful to Professor Deepan Ghosh who was the dean of students during my time at IIT Bombay and Professor Trivedi for inviting me to speak today in Homi Baba auditorium. I consider it as my good fortune to be able to do this. My heart also goes out to Dr. Subindugua for having endowed this lecture series at the TIFR in memory of his dear son, Avik Gua. Avik I discovered today is a beautiful Bengali name, meaning fearless, and I think that is exactly how all research needs to be taking on seemingly insurmountable challenges, fighting it out with grit and along the way dissecting, reflecting and distilling truth to its essence until it is unheard in some recognizable form from beneath its scratchy exteriors. The TIFR is a daunting proposition for any researcher to speak at because it is exactly the place that epitomizes all that I just mentioned about research. So I hope that I can progress some way towards meeting the TIFR's highest standards in the form of my talk by raising an issue that I believe is germane to all of us in today's forum and that is worthy of being tackled in our economy in due course. And this issue is that of monetary transmission in India. Why is it important and why hasn't it worked well? So let me start with some technical jargon that you often will read in the financial newspapers and then try to explain from first principles the part of all this jargon that I wish to focus on. So here's the jargon. With the amendment of the Reserve Bank of India Act in 2016, the primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth. The Monetary Policy Committee or the MPC constituted under the amended RBI Act is mandated to determine the policy repo rate to achieve the specified medium term inflation target of 4% within a band of plus minus 2%. For the Reserve Bank to achieve its mandate effectively, it is extremely important that an economic process referred to as monetary transmission works seamlessly. Any impediment to this process of monetary transmission hampers the achievement of the Reserve Bank's mandate. We therefore monitor and analyze monetary transmission on a regular basis and undertake corrective steps to enhance its efficacy if the process seems broken or critically imperfect. So let me now turn to try and explaining all this or at least some parts of it in simple terms. So what is monetary transmission? It is essentially the process through which the policy actions of the central bank are transmitted to the ultimate objectives of stable inflation and growth. The policy action consists typically of changing the interest rate at which the central bank borrows or lends reserves meaning literally the rupees that you and I are used to on an overnight basis with commercial banks. In other words, monetary transmission is the entire process starting from the change in the policy rate by the central bank so this is the rate at which it borrows and lends rupees with commercial banks. It's the transmission from that rate to various money market rates such as interbank lending rates so the rates at which banks lend to each other to bank deposit rates so these are the rates at which you invest your savings into your corner of the street banks to bank lending rates so these are the rates at which banks make mortgages or lend to firms in the economy to government and corporate bond yields at which government and corporations borrow directly from investors and to asset prices such as stock prices and house prices which we all love to track when we wake up in the morning. I have not yet switched to Facebook and watching the morning posts of my friends so I still look at what's happening to the stock market and the exchange rate. This entire process of the way the policy rate that the central bank sets for doing its overnight operations, how it travels to all these different rates and prices is what is called as monetary transmission. The transmission mechanism hinges crucially on how the policy changes influence households, firms and banks behavior. The change in this behavior can take place through several channels. Studying these channels is a vast subject in the finance and economics literature. In fact, if I had to use one word to describe most of my research I would say it would be how is monetary policy affected when banks in an economy are not in good health. That sort of being the gist of most I have studied in my 20 odd years of research. So given that this is such a vast subject in interest of time I'll only cover a few key aspects. I'll then explain how and why monetary transmission has and more importantly has not always worked in India and touch briefly upon how we could improve it. So let me describe the various channels of monetary transmission. Changes in the central bank's policy rate impact the policy, impact the economy with lags through a variety of channels. The primary ones that are currently being studied are four, the interest rate channel, the credit channel or the bank lending channel, the exchange rate channel and asset price channel. So I'll describe each of these in some detail. So let us start with how the interest rate channel works. The most immediate impact of a change in the monetary policy rate is on the short term money market rates. So short term money market rates are rates such as call money rates. So that is when banks borrow from each other without necessarily providing any security or collateral. Certificates of deposit rates, these are rates at which banks try to borrow at fixed maturities from savers such as you and me. Commercial papers, which is a version of short term paper that corporations access in the market, typically 90 days maturity in order to manage their working capital needs. They have to pay employees, they have to pay their suppliers, etc. And treasury bills, which is what the government issues at short maturities for its own working capital needs. The government also has to pay its bills, pay its employees and meet some immediate cash flow needs on various projects that it may be undertaking. There's also an immediate impact on key financial markets such as exchange rates and equity prices. And also on medium term and long term instruments that I mentioned earlier such as government bonds and corporate bonds which are typically issued at maturity is longer than one year. Now this impact is usually quite quick and broadly one to one from the policy rate to short term money market rates such as the call money rate that I mentioned earlier. And in fact it is so quick that when we release our policy resolution at 2.30pm it becomes public. If there is a significant policy change, it is usually the most perceptible sharp jump in the interest rates, the short term interest rates in the economy in the short segment as I mentioned. So why is it that the policy rate transmits very quickly to the call money rate which is the rate at which banks borrow from each other in the overnight market on an unsecured or uncollateralized basis. So the reasoning is really straightforward. A bank will be willing to part with the reserves or the rupees that it has overnight to another bank only if it earns at least the rate that it could earn by parking these funds with the central bank. So what the central bank is trying to do with its policy rate is basically announce what is the rate at which I as the central bank am willing to do transactions with the banks. Now another bank therefore will lend to yet another bank in the economy only if the return that is going to get by lending overnight exceeds the return that it can earn directly from just parking the funds with the central bank. Now if there are enough banks competing in the market for such lending to the bank that needs the reserves that night it could be for a very simple reason. Why might a bank need reserves that night? Maybe because unexpectedly a large number of its depositors took money out of the ATMs. Then it would be short of reserves to meet its various payments but that's just a temporary need. These savers will bring back some other deposits tomorrow so it can just smooth its reserves need overnight by going to another bank where perhaps as many depositors did not withdraw and they can just help each other smooth their liquidity needs. So if enough banks compete for lending reserves to the bank that needs the reserves then the rate will in fact closely track the central bank's policy rate because the best they can get is to go to the central bank if they try to charge too much above that someone else will actually lend and then in equilibrium the rates will come down. The impact of the policy rate on other market rates is not so direct. It varies based on the tenor or the maturity of the instrument. It also depends on liquidity conditions and other factors such as how much extra compensation is demanded by a lender for parking their funds beyond overnight because then in that time the central bank could change its rates again and now they want to be compensated for the risk that they are taking in the process. But given that the transmission is quite immediate, quick and reasonably good to the rate at which banks lend to each other, the hope is that central banks changes in its policy rate which quickly reflect in this over night funding rates for banks that these will be these are expected to impact the overall cost of funds for banks. Both the rates at which they would the rates that they would pay to depositors and in turn the rates at which they would make loans in the economy. And you can see a similar competition process should work which is that a bank would want to grow its balance sheet by securing more deposits and making more loans. If they know that interest rates in the economy have come down, they know that others are going to bring rates down so they would try to bring the deposit rates down. Once they bring the deposit rates down, they are hoping that their costs have come down so they can actually make loans at cheaper rates. Why is that useful for banks? Because if they lend at cheaper rates, more firms and companies and households will borrow from them rather than from someone else. So even though you lowered your deposit rates, if you can capture a bigger volume of lending that's taking place in the economy, this would be good for the bank's balance sheet as a whole. Now of course in anticipation other banks will do this. They would also want to lend at lower rates so they will bring their deposit rates down and in turn pass on the benefit of those lower rates through loan rates. So when a central bank reduces the policy rate with the intention to support aggregate demand in the economy, that's the kind of jargon central bankers like to use that I'm trying to stimulate demand. I'm trying to restore aggregate demand in the economy. It's done with the policy rate cut is done with the expectation that there would be a reduction in the bank's cost of funds in lending rates and in the whole spectrum of other market interest rates that I described. And as the borrowing rates come down, the hope is that people will find it attractive to purchase homes, buy stocks, buy vehicles and so on and that would create economic activity. So lower lending interest rates of banks generally provide a boost to demand for bank credit from various segments of the society. For instance from individuals and households for loans on consumer durables such as automobiles and for housing and from entrepreneurs for new or increased investment in their plant and machinery. An increased demand for vehicles, housing and machinery in turn generates increased demand for the inputs including labor in these industries. If more vehicles are being demanded, the vehicle manufacturers have to expand their capacity so they will have to increase labor in these industries. And this way you get an overall increase in demand, incomes and output in the economy. So put in a nutshell, this is how a central bank hopes that its policy rate cuts through one channel which is simply the interest rate channel could actually boost the outcomes for the economy. Now as this process continues, the increased demand eventually puts upward pressure on wages of labor and prices of inputs. And this way policy rate cuts eventually start raising inflation in the economy because there's greater demand for labor, there's greater demand for raw materials, inputs and so on. So you can see why a central bank that is mandated to maintain stable prices such as the Reserve Bank of India while taking account of growth faces is a delicate trade-off when it's lowering or raising its policy rates. The implicit assumption that I made in all of this is that bank balance sheets are strong and in a position to step up quickly the supply of credit in response to the lower funding cost and higher demand for credit. This aspect of banks being ready to expand their balance sheets when policy rates are cut, wanting to capture a bigger share of the loan demand is called as the bank lending or the credit channel of the monetary transmission. That's the second channel. Cross-country evidence indicates that monetary transmission is greatly hindered if bank balance sheets are weak in that they do not have much loss absorption capacity to deal squarely with their legacy problem loans. Indeed, evidence that many researchers and I've contributed quite a bit to this literature myself suggests that there might be ever-greening of bad loans or what is called as zombie lending. Lending to distressed firms at subsidized rates to kick the can of their loan defaults down the road. So you know the loan is bad but you just roll it over in the hope that you never have to declare that it's a bad loan because that might require taking a write-down on your buffers. You might violate the central bank's prudential norms about your safety and that could lead to some corrective actions. Indeed, what happens when central banks have attempted to stimulate growth with aggressive policy rate cuts when there are bank balance sheet problems is that very often this policy rate cuts get wasted. The stimulus that I was describing earlier doesn't happen because banks are actually not in a position to compete for increasing loans in the economy. They're actually more worried about the problems that are haunting them from their past legacy loans. It usually ends up in misallocation of resources, productivity losses and weak growth, what the Austrian economists have called mal-investments. The rate cuts however create false hopes of growth boost and in fact relax the pedal on deeper balance sheet and structural reforms of the banking sector. The effectiveness of this bank credit channel is a critical issue in the current juncture in India to which I'll come back a bit later. Let me now talk about the third and the fourth channel very briefly. Lower interest rates also boost asset prices such as housing and equity prices. Take housing for example with lower interest rates and lower mortgages if the credit channel is working well. Then because houses can be purchased cheaper there'll be a greater competition for buying houses on part of the savers in the economy and that will actually cause the housing prices to rise because housing inventory is not going to adjust on an instantaneous basis to the renewed demand in the economy. So the resulting boost to household or more generally even corporate wealth and improved cash flows on the back of lower interest rates because you are getting your same capacity to consume or invest but now you have a lower interest rate cost to pay. These also add to the demand impulses in the economy and this is called as the asset price channel of monetary transmission. In fact these things can create a sort of a virtuous cycle. Higher asset prices can enhance the value of the collateral or net worth of the household. So if housing prices are rising banks would be more willing to lend to the households. Now this in turn can again actually boost the bank lending or the credit channel I was just describing earlier. Finally lower domestic interest rates could lead to a depreciation of the domestic currency because anyone bringing their dollars into the country converting into rupees is going to earn a lower rate. On the one hand this depreciation will make exports more competitive in the global market and because there are more exports the export segment of your corporates will add to domestic demand and economic activity but you can see that this doesn't necessarily have to go one way. It could because a depreciated currency will also have a direct upward impact on the domestic currency prices of imported inputs. In our case the most important one being crude oil as you might have been reading it has appreciated in prices substantially over the last quarter. In any way whichever way this plays out this is called as the exchange rate channel of monetary transmission. All these channels that I have described the interest rate channel the bank lending or credit channel the asset price channel and the exchange rate channel they are not standalone channels they all are working together in the economy sometimes they reinforce and interact with each other so that their individual impact is quite often difficult to disentangle and therefore this vast body of finance and economics work that's trying to ferret out how these channels are getting transmitted in the economy. It also needs to be recognized that this mechanism is rather complex I've tried to simplify it as much as I could. The speed and strength at which the central bank's policy rate changes travel to the rest of the economy also varies widely from country to country depending on the structure of the economy and the state of the financial system. In fact a very important topic on monetary policy including in India is the lags at which central bank's policy rate cuts actually get transmitted to the rest of the economy. So all these processes that I described that banks have to compete for making loans they have to ensure that there's enough buffers in their balance sheets to make these loans the fact that asset prices or housing prices may rise and in turn create another round of loans because households net worth is perceived to be greater if house prices are rising. All of these things don't happen instantaneously or overnight like the immediate impact that gets transmitted to the short term rates in the economy. So the available data evidence for India suggests that monetary policy actions of the reserve bank they are felt by the real economy with a lag of two to three quarters on output and with a lag of three to four quarters on inflation the building up of prices and the impact usually persists for much longer about two to three years eight to twelve quarters. Among the channels of transmission for India the interest rate channel the first channel that I described in some detail has been found to be the strongest the fact that central bank changing the rates on overnight funding it produces an immediate impact on the rates at which banks exchange liquidity through that it alters deposit rates loan rates and so on. Given that monetary policy impacts output and inflation with these kinds of long and often variable lags sometimes it may be two quarters sometimes four quarters depending upon the health of the banking system typically the latent demand for growth in the economy it is critical for monetary policy actions to be forward-looking that monetary policy needs to respond to expected output and inflation developments rather than just what has happened in the last few quarters. Now of course expected evolution of output and inflation is uncertain thereby rendering the transmission analysis even more challenging adding to the complexity of the central bank's decision-making and if I may say so creating exciting opportunities for our critiques in media and elsewhere. But the key point I want to drive home from all this is that if parts of this transmission machinery are broken then monetary policy would be less effective and sometimes the analogy I used to give to my students at NYU was of how the gas pumps in Manhattan used to work. I had never actually asked the question how fuel reaches the gas pumps in the gas stations in the city of New York until Hurricane Sandy actually hit the shores of New Jersey rather hard and suddenly one of the collateral damage from that was that there was no gas being filled up in the gas stations in New York City. And so this monetary transmission is a little bit like the assumed plumbing of the economy that's supposed to work seamlessly central bank cuts rates, beautiful things should happen to the economy until it gets too good inflation picks up and then you rotate the dial back a little bit and so on. And it's only when it fails that you actually start asking the question what's really going on, where are these vis and the gas traveling from the shores of New Jersey to the gas stations in New York allowing vehicles to go, allowing children to go to their schools, people to go to their work stations and so on. So let me therefore talk about the performance of this transmission from policy rate to bank lending rates in India. There's a reason why I'm talking about it today because we think that we need to improve this performance. So let me describe it. Let me give you a little bit of history. Talk about how it has behaved. What may be the factors as to why it may not have worked as well as one might have wanted it to be. The Indian financial system remains bank dominated though the share of non-bank finance companies and market funding through corporate bonds, commercial paper, stocks, et cetera in the overall financing of the economy is also rising steadily. But I think at this point it's fair to say that the overall efficacy of monetary transmission in India hinges critically on the extent and the pace with which banks taking a cue from and induced by the changes in the Reserve Bank's policy repo rate adjust their deposit and lending rates and then compete to meet adequately the economy's demand for credit. Overall the data that we have analyzed seems to suggest that the pass through from policy rate changes to bank lending rates has been rather slow and in fact muted. This lack of adequate monetary transmission remains a key policy concern for us as the central bank because it blunts the impact of its policy changes on economic activity and inflation. So if the transmission is not working at all, so if the central bank or the monetary policy committee cuts or raises interest rates and nothing happens to the economy, then the only reason for us to move the dial would be to use it as a fidget toy so that we don't do any other damage during the rest of the day. Let's just turn the dial a little bit. This is literally what I tell my mother-in-law when she asks me why do you need to change interest rates every two months. I tell her listen on a light note, I do it because it's my fidget toy. But of course what's supposed to work is that all this monetary transmission is supposed to take place in the manner that I just described and if it takes place it's really, really a powerful fidget toy. It's actually going to completely alter the demand and growth and the prices, etc. as I described in the economy. Okay, so let me come to sharing a little bit of the Indian experience on the performance of this monetary transmission. Since the deregulation of interest rates in the early 1990s, leaving the rates to markets, to financial institutions, to banks, the Reserve Bank has made several attempts to improve the speed and extent of the monetary pass-through by refining the process of setting the lending interest rates by banks. While at the same time imparting transparency about this rate setting process for borrowers and giving flexibility to banks in the process of their interest rate setting. In fact, we have transited across several systems from the prime lending rate or PLR system in 1994 to the benchmark prime lending rate or BPLR system in 2003 to the base rate system in 2010 to the present marginal cost of funds based lending rate or MCLR system in 2016. Let me explain these interest rate setting regimes briefly before I turn to an assessment of the more recent regimes, which are the base rate, which is the immediate legacy regime and the prevalent MCLR rate setting system. So in India, as in a number of other countries, a large proportion of loans is at floating rates. That is the interest rate that is charged to the borrower. So if I am the borrower that has taken a mortgage from my corner of the street bank, the interest rate keeps changing year to year. That's the current typical reset periodicity of these interest rates. The floating rate on my mortgage is usually linked to some benchmark rate, which should ideally vary in consonance with the changing macroeconomic and financial conditions. And from the central bank's perspective, if the monetary policy is to be effective, this benchmark rate should also move in consonance with the policy rate or the dial that I was describing earlier. Typically, banks will also charge a spread over the benchmark rate to factor in term premium and credit risk. So my mortgage is not overnight. It's actually over a 10, 15, or 20-year period. Lots of interest rate changes will take place. Maybe I'm a decent credit now, but I'm going downhill. And that is something that the banks would have to charge premium for because they would have to take possession of the property, liquidate it in case I can't pay my mortgage off. So there will be a spread on top of the benchmark rate. And that, together, the benchmark plus that spread is what will be my lending rate. And this will keep getting reset periodically, typically right now at an annual frequency. The benchmark, which is what's going to ideally be fluctuating with the central bank's policy rate, could be of two types. It could be internal or external. An internal benchmark will be based on elements which are in part under the control of the bank that's giving me the mortgage. What are the factors that might drive it? It's the bank's cost of funds because it will like to recover its cost of funds on the loans that it makes. All the four systems that I mentioned to you are functioning right now as though they are internal benchmark systems. In contrast, an external benchmark is a rate that is outside the control of the bank that's making the mortgage to me. For example, it could be determined in the market, such as a certificate of deposit rate on average across banks. It could be a treasury bill rate, say the 90-day borrowing cost of the government of India. It could be an interbank offer rate, the rate at which banks are lending to each other overnight or at some other maturity. Or simply, it could just be the central bank's policy rate. All these rates are outside of the control of one individual bank out there. They are sort of market-determined rates. Now, this is an important distinction. The virtue of an external benchmark rate is that it is transparent. Everyone will be able to find exactly the same rate as to what is the reserve bank of India's policy rate right now. Or what is the three-month T-bill rate in the market right now. So it's transparent. It is common across banks. And therefore, borrowers can compare various loan offers by simply comparing the spreads that they are being charged over the benchmark provided all else is equal. So if I'm shopping around for mortgages, and if all mortgages are tied to the central bank's policy rate, and then one bank is giving me a 1% extra mortgage rate on top of that, and another bank is giving me 1.5% over the central bank's policy rate, they are both for 20 years of maturity. There are no other strings attached. Then I know that the first mortgage is cheaper than the other mortgage by 0.5 percentage points. So unless I really have a good reason to prefer the other bank because I think the relationship manager will give me good service when I go to the bank branch, et cetera, I would go to the cheaper mortgage. So I can compare if benchmarks are transparent, common across banks, I just have to compare spreads and it makes it easy for borrowers to shop around for the best products that they have. And what's important about this is that this can facilitate competition in the lending, which will then bring the rates down when we are trying to stimulate the economy with a policy rate cut. Now as market rates normally move in line with the central bank's policy rate, an external benchmark is globally considered and adopted as more appropriate than an internal benchmark that is set individually by each bank for transmitting the monetary policy signals. In India, the Reserve Bank has provided banks flexibility to use both internal and external benchmarks. But the banks have preferred internal benchmark so far over external benchmarks on two key grounds. First, that internal benchmark reflects their cost of funds, whereas some other market rates may not exactly reflect their cost of funds. I'm going to spend quite a bit of time on this point. And second, it has been perceived that there have not been until recently any robust and vibrant external market benchmarks. I'll come back to this point as well. Okay, so now having described this benchmark interest rate setting process, let me walk you through the four internal benchmarks that we have. Bear with me. This is minutiae that I also don't want to dig into on a day-to-day basis. But to give you a complete picture of how we have arrived at where we have arrived, I'm just going to walk you through the history of all this a little bit. In October 94, when the Reserve Bank deregulated lending rates for credit limits over rupees 2 lakhs, so if a bank was making mortgages or loans which had quantum over rupees 2 lakhs, banks were required to declare their prime lending rates or PLR. These were the interest rates charged by banks to their most credit worthy borrowers, so prime lending rates, lending rates for your prime borrowers. Of course, this would still take into account factors such as cost of funds and transactions cost for servicing mortgages, loans, etc. The PLR or the prime lending rate was expected to act as a floor for loans that were above rupees 2 lakhs. The experience with its working of this prime lending rate setting process, however, was not satisfactory mainly for two reasons. One, the prime lending rate and the spread that the banks charged over the prime lending rate seemed to vary quite widely and inexplicably across banks. And perhaps more importantly, the prime lending rates of banks were rigid and inflexible in relation to the overall direction of interest rates in the economy. And you can see here that where I'm trying to gradually move to is to explain how parts of the monetary transmission machinery could start creaking with the internal benchmarks that I'm talking about because it gives banks certain discretion over setting of the benchmark rate process. So even though the central bank has cut the policy rate, the market rates have moved, the bank now has a discretionary choice whether it wants to move its rate or not. Now, because the rates set by different banks are all discretionary, it's not easy for a borrower to compare two banks mortgages because when one bank says it's PLR plus 1% and another bank says it's my PLR plus 1%, the two PLRs are not exactly the same. And so I cannot compare these mortgages on an Apple to Apple basis. They are actually different products because their lending rates are being chosen by that bank and every year when these rates set, it's again going to be another discretionary choice that this bank is going to exercise at that point. Now, in view of these concerns, the Reserve Bank advised banks in April 2003 to announce benchmark prime lending rates where it now tried to get a little more prescriptive, not let the entire rate be the discretion of the bank, but guide them as to what should be the factors that should go into the setting of the benchmark lending rates. So banks had to take into account their cost of funds, operational costs, whatever minimum margin they had to earn to save some buffers on their balance sheets, so keep some savings on balance sheets to meet the risks and the losses that they might incur on loans, and some other profit margins that might be important for the bank to grow. This new system, the benchmark prime lending rate or the BPLR system over time was also found to fall short of its desired objective of enhancing transparency and serving as the reference rate for pricing of loan products. In fact, what used to happen is that a large part of the lending used to take place at interest rates below the benchmark prime lending rates. And basically it created a lot of confusion and obfuscation as to what exactly is the benchmark rate at which loans are being made in the economy. In fact, the share of loans that were taking place below the BPLR was as high as 77% in September 2008, rendering it difficult for the central bank to assess the transmission of policy rate changes to lending rates of banks. And you can imagine that if it was hard for us to understand the transmission, how hard it must be for borrowers to actually compare different loan offers that they were getting in the market. The residential housing loans and the consumer-durable loans were at that point outside the purview of the BPLR. But as such, all this sub-BPLR lending became a major distortion because you could cross-subsidize one set of loans. So, for example, if you had to ever green your corporate loans, you would need to lend to your corporate loans at very low rates. Then you would keep them sub-BPLR but charge everyone else at the reference rate or the benchmark rate. So you would go and make a mortgage at the benchmark rate but keep a lot of loans under the reference rate because you had to just roll them over at that point. Then the drawbacks of this BPLR system led to the introduction of a new system called the base rate system in July 2010. The base rate was also based, among other things, on the costs of borrowed funds. Now there was, in fact, an indicative formula for arriving at the base rate that was provided to banks by the Reserve Bank. Again, the base rate was to be the minimum rate for all loans except for some special categories. With the actual lending rate charged to the borrowers being the base rate plus borrower-specific charge or spread. As I described, my credit quality could change over time when there would be some credit premium on the loan. In practice, the flexibility accorded to banks in the determination of cost of funds. Now whether it's your average cost of funds, you might have taken some deposits three years back, some two years back, and some you are rolling over now in the market. So is it the average cost of all the deposits that you have on your balance sheet? Is it just the marginal cost? Is it the cost of raising new funding from deposits in the market? Or is it some blended cost of new rates and past rates? This discretion as to how the cost of funds is calculated, this now introduced opacity in the determination of lending rates by banks, and once again clouded an accurate assessment of the speed and strength of the transmission. Further, of course, banks are adjusting the spreads over the base rate, but now you cannot look at the spreads in isolation because the benchmark rate itself is under the discretion of the banks. And so the whole analysis of how the transmission is working became extremely complex to analyze. And invariably, the consequence of this has been that when policy rates have been cut by the reserve bank, they are not getting passed on to the borrowers at the pace and nimbleness that we would like the transmission to work. The weakness and the rigidities observed with transmission under the base rate system then led to the present system, which is called as the MCLR system starting April 1st, 2016. Now it was felt that the base rate, because it's some average rate, it moves very slowly. So suppose the Reserve Bank of India has cut interest rates by 50 basis points over the last two quarters, that hasn't necessarily changed the rate on my deposits that were taken three years back or two years back if they were fixed term deposits. So if I have to change my benchmark rate based on the average rate of my funding, even though the interest rates have been cut by 50 basis points, the central bank will not change the base rate that the banks in the economy will not change the base rate that quickly because it's only the new deposits that will reflect the lowered cost of funding in the economy. So now the banks under the MCLR system were asked to take into account the marginal cost of funds. That's the new financing that the bank is raising. Unlike the base rate system where as I said they could choose between the average cost or the marginal cost or a blended version of that cost. Under MCLR banks were required to do this based on the marginal cost of finance. Now again, progressively as we moved from the PLR to BPLR to base rate to MCLR, the hope was that now that we've made it based on the marginal finance, the lending rates in the economy will become more sensitive to changes in the policy rate vis-à-vis all its predecessors. Of course, again the actual lending rate will be the MCLR of the bank plus a spread which again will reflect some credit risk premium. The base rate system was allowed to be in operation at the same time that the MCLR system was introduced to contract new loans because it was felt that these contracts on base rates will mature at some point and then will just be left with the MCLR system. Now all of these rates have this one property that they are internal benchmarks. They are left to the discretion of being set by each bank rather than being set by a market or rather than being set by the central bank itself like its policy rate. And the expected benefits of the MCLR system, better transparency, more flexibility and most importantly, faster transmission from policy rate to the real economy. However, have continued to elude as documented in Reserve Bank's recent study called report of the internal study group to review the working of the marginal cost of funds based lending rate system chaired by Dr. Janakraj from our Monetary Policy Department. The analysis in this report indicates that the transmission, it has four critical results that the transmission has been slow and incomplete under both the base rate and the MCLR system. So let me just show that. So this is a table that summarizes this transmission. I'll just try and explain this. Focus on the first column, that's the central bank's policy rate or the repo rate and it's over different periods. So take the first two periods, October 2017 over end December 2014. So what has been the cumulative change in the central bank's policy rate over that period? It's been two percentage points or 200 basis points. From October 17 over just April 2016, why am I choosing April 2016? Because that's the date when the latest MCLR rate setting system was introduced. Over that period, the repo rate or the policy rate was changed by 75 basis points. Now you can see that over this period, the term deposit rates of banks, I've given two measures over there. They have sort of reflected the policy rate. So as the policy rate changed by 200 basis points, the median deposit rate of banks changed by 166 basis points. So for a two percentage point policy rate cut, bank's deposit rates changed by 1.66%. And in fact, instead of taking median, if I weigh the size of the deposits while weighing the overall deposit rate of the bank, in fact the pass through is almost one for one. The deposit rates weighted by the sizes of deposits came down by exactly 299 basis points. So that's a pretty good pass through that we would want in the economy. So that's one leg that's working well. Now why do we want the deposit rates to come down? We want the deposit rates to come down so that a bank says, okay, I have lower cost of funds. Let me go and outbid someone else in the market for lending because then I'll get new loan volume coming to me. How do I do that? I have lower cost of funds. I can go and lower my lending rates. And then if the lending rates come down, that virtuous cycle of growth, et cetera, takes hold. But if you go to the right, you see that the lending rates don't actually reflect as strongly this pass through. The median base rate, in fact, changed only by 75 basis points. So 50% of the bank portfolio, which was the legacy portfolio tied to the base rate as the benchmark lending rate, when those rates are reset, even though bank's deposit rates have come down by as much as 200 basis points, the rate that is getting passed on to the outstanding loans is actually only 75 basis points. On the fresh rupee loans, which are the new loans that are taking place, there is better outcomes. There is more competition over there. And you can see that the pass through there in the rightmost column is 1.92 percentage points. So there the transmission is working well. So it seems that banks do well in competing for the new loans. However, if I have an existing mortgage, no one is knocking on my doors and telling me, do you want to refinance this mortgage because I can actually offer you a cheaper mortgage, my cost of funds has in fact gone down. And we observe the pass through as being not that perfect, even over April 1st, 2016, which is the MCLR system, you can see that the base rate over that 18 month period or slightly over 12 month period as the pass through is only 15 basis points for a 75 basis point rate cut. So we are cutting interest rates by 0.75%, but only one fifth of it is getting reflected into the outstanding legacy loans of banks. So to summarize, the pass through is slow. It's incomplete. It's significant on fresh loans, but muted for outstanding loans. And that's true both under the base rate system as well as the MCLR system. I'm not showing this here, but we find that the pass through is actually uneven across borrowing categories. And it's also asymmetric. It doesn't work the same way when we are tightening versus when we are cutting rates. In fact, as you can expect, the transmission, because it is left as a discretion to the banks, has worked where when we tighten rates, the pass through through lending rates is faster. The loan rates increase at a faster pace when central bank raises rates, but not as quickly in terms of the reduction in the rates. So what explains the slow and incomplete pass through from the policy rate changes to the lending rates? I think it's critical to understand the economics of this to know what perhaps might have to be done. And two broad factors emerge as having dampened the transmission to the lending rates. First, as I said, a sizable legacy loan portfolio of banks is still linked to the base rate. Lending rates under the base rate system are relatively stickier than the loans that are linked to MCLR because the base rate banks have chosen to set based on these average rates. So during the current easing cycle of monetary policy, as against 200 basis points or two percentage points of cumulative cut in the repo rate, the base rate has declined only by 80 basis points or 0.8%. Since the introduction of the MCLR in April 2016, as against the cumulative cut in repo rate by 75 basis points, the base rate has declined by just about 20 basis points. In the study group that analyzed this in our team at Reserve Bank, their analysis suggested that banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR. So in moving from the PLR to BPLR to base rate and MCLR, progressively the Reserve Bank got more prescriptive in the formula for setting the benchmark rates. But then, you know, the cost of funds, the operational costs, these are still left as discretionary choices of the banks. And we found that these choices were quite ad hoc so that the banks had great flexibility to either inflate the base rate on the MCLR and prevent them from falling quickly in line with their cost of funds. And so what is the game that is going on in some sense is that your deposit rates come down, but if your lending rates don't come down at the same pace, and if no one is actually able to see through as to how much should my lending rates come down, you can keep earning a fat margin as a bank. In fact, you can see this visually as well, which is that whenever policy repo rate is getting cut, which is the rate at the bottom, you can see that one-year median MCLR is coming down, but not one-for-one. Whereas the red line, which is the base rate, is actually even slower in adjusting. Another way you can look at transmission is what is the slope of this line. So if you plot on your y-axis the MCLR rate or the base rate and on x-axis the policy repo rate, if this has a slope of one, so it's a 45-degree line, then the pass-through is one-for-one. That would be the simplest way of knowing whether your monetary pass-through is working well or not. You can see that this line is not like it's actually pretty flat. It doesn't have a slope of one. It's either one-fifth or one-third or something like that. So the second reason, so the first reason is that there is ad hocness in the benchmark rate itself. Second, spreads that are charged by banks over the benchmark rate, such as the base rate or MCLR, they are also adjusted to offset the changes in the benchmark rate. So suppose that the benchmark rate is supposed to come down by 50 basis points or 75 basis points. So I change my benchmark rate, but at the reset point on the mortgage, I now increase my spread by 75 basis points. Then actually, there is no net transmission that took place to the borrower because whatever is happening on the benchmark rate, I'm completely offsetting on the spread on the other side. Now, of course, the spread over the benchmark rate could vary from bank to bank due to a variety of reasons, but the study group, through careful analysis, observed that these spreads were also getting adjusted quite arbitrarily, and the variation in spreads across banks for similar quality borrowers was too large to be explained purely on the basis of borrower's health or risk of the borrower defaulting or their credit risk, as they call it. So these spreads were expected to play only a small role in transmission. The big role was supposed to be played by the movement in the benchmark, but the spread was actually playing quite a big role in the overall transmission process as well. So why has this come about? Why is it that the pass through is so muted? Why is this line flat rather than being a 45-degree slope one line? So one plausible underlying reason that is proposed by banks, and I think it's reasonable, is the rigidity on the liability side of their banks, which is that in India about 90% of total liabilities of banks are in the form of deposits that you and I make with the banks. We deposit our savings, hoping that we can withdraw them when we want. Sometimes we put them into fixed term deposits to earn slightly higher rates. But as you must have observed through your banking transactions, bank deposit rates are predominantly at fixed interest rates. They are not actually floating rates. When you get a deposit rate, it's given to you at some fixed rate, 5%, 7%, 8%. It's not something that's sold to you by saying, oh, this is going to fluctuate up and down with how the central bank is actually managing the policy rate in the economy. Now, of course, if these deposit rates therefore take time to adjust because only the new deposits will reflect the new policy rates in the economy, there's going to be some rigidity in the transmission process. Further, over 36% of these deposits of banks have maturities which are three years and above. So here's a table that shows what is the maturity of deposits. So if my deposits are very short term, then pretty much everything is getting renewed. So in the extreme, think about all, suppose all of your deposits were just overnight maturity. Every night, the bank is actually setting a new interest rate on your deposit. That would be very good for monetary policy pass through because as the market rate changes, the banks will change and provide you a new rate on your deposit. But what you observe progressively as you go to the right, if you look at three years to five years, you can see that even now about 26% of the deposits are in three years and above maturity. On average, they have been actually over 36%. Implying that a part of the funding cost of banks is getting reset infrequently and with significant lags to the policy rate changes. So the average cost of deposits of banks is coming down rather slowly and that's not good for transmission through the bank balance sheets. What is also not recognized is that large access that our banks have to low cost current and savings account funds. They are called as CASA in the banking parlance. These CASA funds constitute about 40% of aggregate bank deposits with the share of saving deposits at around 31%. Banks are free to decide saving deposit interest rates since October 2011 and the hope was that if you just set these free, then when the policy rates are cut, the deposit rates will come down quickly and vice versa. But until recently, most banks chose to leave the savings deposit rates unchanged. In fact, ignoring completely the monetary policy movement or impulses. Major banks kept their saving deposit rates unchanged at 4% between October 2011 and July 2017. So almost a six year period. Even as the reserve bank's policy rate moved significantly over this period from 8.5% in October 2011 to 7.25% in August 2013. It increased again to 8% by January 2014 before declining to 6% by August 2017, but this doesn't produce a parallel sort of a movement in the CASA deposit rates of banks. Furthermore, and quite importantly, there has been a deterioration in banking sector health in the past several years due to worsening of asset quality and the expected loan losses in credit portfolios. These have made banks capacity to bear losses on fresh loans quite low so that they are now keen to earn very high margins on the new loans that are coming out there. In effect, there is a cross subsidization from the margins that are earned on new loans against the losses that are going to happen on the legacy bad loans that these banks have and these stressed assets are presently quite large. So to maintain their profitability in the wake of these large losses that are coming due on a big part of the public sector banking system, banks are wanting to keep lending rates quite high relative to the deposit rates. As a result, also the transmission to lending rates has been severely impacted. And finally, the competition that banks face from alternative instruments of financial savings such as mutual funds and small saving schemes, they also seem to have made banks hesitant in varying the interest rates on term deposits in concernance with policy rate signals. So bank deposits do have some advantages in the form of stable returns compared to mutual fund schemes where there might be investments in market securities like equities or bonds whose prices are fluctuating in the market on a day-to-day basis. They might not be as liquid as a bank deposit. You might not be able to withdraw it intraday if you want. You might have to wait till end of day liquidations. But bank deposits can be in a disadvantageous position if there are tax advantages in comparison to this scheme. So if you don't withdraw from your mutual fund scheme for longer than a year, if you don't have to pay, then for the same return you would rather take a mutual fund scheme than a deposit because of the preferential tax advantage. So all of these factors have imparted rigidity to the liability side of banks' balance sheets with respect to policy rate changes. So I've done two parts so far. I know it's taking long, but I'm getting to the end. I've spoken about what monetary transmission is and how it is supposed to work. And then I've explained that it's not working as smoothly as one would like in India in spite of these attempts to change the internal benchmarks and making them less discretionary, more prescriptive, but still with some discretion on the inputs that the banks are putting into all this. And as I explained, it's also in a time when perhaps, especially over the last few years, the health of public sector banks has been not as great as one might have like. So how do we improve transmission? What's the way forward? So drawing from its comprehensive analysis, the RBI study group has suggested a number of steps to enhance transparency and transmission from monetary policy signals to the actual lending rates. Their recommendations pertain to improving transmission based on the existing lending rate system as well as proposing a fundamental reform of the interest rate setting process. So let me touch upon the four major recommendations of the study group. Essentially, the study group concludes that because of the less-than-desired performance of internal benchmark lending rate systems, there is a need to shift to an external benchmark-based lending rate system. The internal regimes are not in sync with global practices on pricing of bank loans or mortgages. And given the scope of arbitrariness under all of these internal benchmark systems, the study group has recommended that the switch over to an external benchmark needs to be pursued in a time-bound manner. While recognizing that no external benchmark in India meets all the requirements of an ideal benchmark, and after analyzing the pros and cons of 13 possible market-determined candidates, the study group has recommended three, the treasury bill rate. This is the rate at which the government of India borrows in the short term to meet its own cash flow needs or liquidity needs. The certificate of deposit rate. These are the rates that you can aggregate across the highest credit banks in the economy at some short maturity, say three months, six months, 12 months. And the third is the Reserve Bank of India's policy repo rate, the dial that I was mentioning that we change. According to the study group, these three benchmark rates are better suited than other interest rates to serve the role of an external benchmark. The group has recommended that all floating rate loans that are extended beginning April 1, 2018 could be referenced to one of these three external benchmarks which the Reserve Bank might select based on the feedback that we are receiving and evaluating from various stakeholders on this proposal. Second, the study group has recommended that the decision on the spread over the external benchmark be left entirely to the commercial judgment of banks. However, this spread remained fixed through the term of the loan. Okay, so what's going to be in what is being proposed, what will float is what is linked to the market rate, and that in turn would move as I was explaining with the policy rate changes that the central bank brings about. Banks can price in whatever they want about credit risk, maturity risk, et cetera, and give you a spread, but then that spread on top of the benchmark under the study group's proposal will remain fixed during the term. So when a borrower goes and takes a mortgage or a loan from a bank, they know that the only component that's going to fluctuate over time now is actually going to be the pure interest rate or the external benchmark component. Now, of course, if there is a credit event which is that the borrower's condition deteriorates in a very material way, then the contract, the borrower and the lender could agree that in that case we will reset even the spread on this loan. Third recommendation is that the periodicity of resetting the interest rates by banks on all floating rate loans, retail as well as corporate, so mortgages as well as corporate loans and other personal loans, it be reduced from once a year to once in a quarter so that if policy rates are cut, actually the reset points are going to happen not with a lag of four quarters, but at most with a lag of one quarter after the policy rate has been cut. So this would expedite the pass through from the monetary policy signal to the actual lending rates. And fourth, to reduce the rigidity on the deposit side, banks be encouraged to accept deposits, especially bulk deposits, the large volume deposits at floating rates that are also linked to the selected external benchmark, because then bulk of your deposits, which are, say, your wholesale liabilities, not the deposit that comes from me, but say a deposit that comes from a large corporate savings, that would also change with the central bank's policy rate, so the cost of funds will come down quickly and the lending rate is also going to come down quickly, the spread will remain fixed. And so what's primarily happening then through transmission is that all rates in the economy will come down one for one, and the stimulus that we are hoping will actually go through more seamlessly. The common theme underlying all these recommendations is therefore to improve the monetary policy transmission so that the changes transmit quickly and adequately to banks' lending rates, and importantly in a transparent manner. If two banks come to you with a mortgage, you should be able to tell fairly quickly which is the cheaper product out of these two. Right now that's not so easy to do. And we also want to make the liability side more flexible to address the bank's concern that, oh, my deposit cost is rather rigid, that doesn't move with your policy rate, so why should I cut my lending rates? So even that would get addressed if at least the bulk deposits are also switched to the floating rate benchmark. The report has been put up in public domain on October 4, 2017. If you took immense liking to what I had to say today, then please go and look up the report. You will see a lot of details there. We have been receiving feedback from all stakeholders, not just banks, but also general public and media. We'll be evaluating this feedback and suggestions quite carefully and take a considered view factoring in transition costs of moving from a base rate and MCLR to an external benchmark and provide some calibrated path over a period of time to the desired benchmarking system. Before I close, I have to touch upon the issue that I mentioned about shoring up of bank balance sheets or the credit channel of monetary transmission. One reason while weak demand for bank credit could be one of the factors leading to the observed slowdown in credit growth over the past four, five years, a primary cause for the slowdown has been found in our research to also be the weak balance sheets, especially of public sector banks, in view of their large non-performing assets. They seem to have made banks quite risk-averse and induced in the economy a reduction in the supply of credit. In fact, what's interesting is that undercapitalized banks essentially have capital to survive, but not necessarily to grow. This supply-side factor, which is that even if the central bank cuts policy rates, market rates might change, but banks are not in a position to compete in the market for loans because there are no buffers for taking further losses. This one way to identify this is because our private banks, our non-bank finance companies such as housing finance companies, they are in better balance sheet conditions and their credit growth has been on the order of 15 to 20% relative to almost stagnant credit growth for public sector banks. So against this backdrop, there are some important changes taking place in the economy. There is the enactment of the insolvency and bankruptcy code in December of last year, December 16. The promulgation of the Banking Regulation Amendment Ordinance of 2017 since notified as an act that allows the Reserve Bank to ask banks to direct the large corporate borrowers whose loans have gone bad to the bankruptcy code, hoping that the largest material and those assets which have been non-performing assets for a long time, they actually be resolved in bankruptcy in a time-bound manner. What is the advantage? The advantage is that if banks recognize the losses, then they can be recapitalized to the right levels and then they can start lending to the healthier parts of the economy again. So these initiatives, the insolvency and bankruptcy code and the ordinance and then the act allowing the Reserve Bank to direct cases or reference cases to the bankruptcy code, these are now being supported by the government's decision to recapitalize public sector banks in a front-loaded manner. So there will be some initial capital injections with a total allocation of rupees 2.1 trillion comprising some budgetary provisions up to rupees 181 billion, some recapitalization bonds that the government will issue on the balance sheets of these banks up to rupees 1.35 trillion and there will also be raising of capital in the market by banks in the form of equity fund raising. Essentially the public sector banks will be diluting government equity share up to 52 percent and this is, this fund raising is expected to be around rupees 580 billion. These two steps together, asset resolution and bank recapitalization are expected to strengthen bank balance sheets significantly and improve their ability and willingness to lend at rates that are more consistent with the policy rates. This would result also in better monetary transmission, potentially creating the virtuous cycle of growth and stability that I was talking about. So there are essentially two reforms that are being proposed as I said, one is still in works which is to change the process of benchmarking, spread setting, the reset frequency and making the deposits of banks fluctuate with the policy rates and then fixing the conditions of the banks so that if there is capacity in the economy to grow, they have the ability and the willingness to actually compete there. So let me conclude in my view there is a deeper economic question at hand in all these recommendations, especially in the recommendation in moving towards an external benchmark and the issue is the following. I just want to leave it with you as a thought question, which is if interest rates in the economy have to be moved to steer the economy to stable growth, etc., who should bear the interest rate risk that gets created in the end? Should it be the borrower? Should it be the saver or the depositor in the economy like some of us or should it be the banks? Who is likely to be better at managing and distributing this interest rate risk in rest of the economy? Retail depositors and borrowers like you and me are unlikely to have efficient tools in my opinion to manage the fluctuations in the interest rate risk. We'll just have to absorb them into our lifestyles in one way or the other cutback on spending if the cost of mortgage becomes too high relative to the inflation in our wages, for example. Banks, however, should ideally have the wherewithal to manage the interest rate risk. They should have the sophistication to figure out where to lay off this risk that's coming on their balance sheet. Similarly, bulk depositors and large corporate borrowers can also be expected to be in a position to manage this interest rate risk. Many of the large corporations have their own treasuries that should actually try to shop around and figure out how to pass around this interest rate risk elsewhere. Non-bank financial institutions with less exposure to interest rate risk than banks, such as insurance and pension funds. They have savings that are going to stay with them for a very long period of time. They could also be good repositories of this risk. So banks can create this risk, but then we could find ways of repackaging these risks to those who actually have savings for a much longer horizon than deposits that are out there. Foreign banks could come into the ecosystem to offset the interest rate risks of our economy globally because the interest rate cycle in other economies may not be happening in exactly the same sink as our interest rate cycle is moving. A combination of such interest rate risk transfer mechanisms through market products, such as interest rate derivatives, which are now prevalent in most large economies, and then what are called as securitized products where banks take a large pool of loans or mortgages and repackage certain risks such as interest rate risk of that portfolio to insurance companies, pension companies, and other investors, these would have to in parallel emerge in our economy so that banks also don't necessarily have to bear these risks. They don't have to have rigid balance sheet structures. Hopefully I'll focus sometime soon on these issues in a companion piece. I guess it would be titled Monetary Transmission in India. How can it be improved? So let me stop there. I think if there is time I can take a couple of questions, but I don't know if you guys are really hungry or thank you. If you can also introduce yourself, so I know your context and background in replying. Hello. Good evening, Dr. Acharya. I'm an economist from background. My background is of economics. My question to you is that in the last 12 months, our economy has faced two shops, demonetization, which squeezed demand, and the GST rollout, which squeezed supply. As a result of which, we have lagged our Asian payers in terms of our exports growth. If you look at the exports growth of our Asian countries, they have been growing at a faster pace than what Indian economy, Indian export is. If you look at the previous GDP print, which was 5.7%, the government spending which supported it was to the tune of 140 basis point. Stripping that off, the GDP growth was 2.3%. And the drag due to higher imports was 280 basis point. So do you think that moving on, even though the growth picks up, we may find that the government no longer has the means to support it because there has been a big chunk of government spending, front loading in the first half of the fiscal year. So given that narrative and that the inflation is expected to rise here on as per your MPC reports, do you think there is a scope for or the need for further easing in the policy rates? Yeah, that's a good question. I can see that just as I've given a long speech, you've also given a long question. So, you know, it would not be right for me to speculate on the monetary policy committee's decisions going forward. But I think what I would say in the context of the talk that I gave today is that we believe that there is further scope for transmission of monetary policy accommodation or policy rate cuts that have already taken place. We think that there is actually scope for further transmission. And in some sense, the objective of the RBI study and the reforms that I proposed have been to try and see if we can deliver on what we have already done through our policy change, but get it to the end users in the real economy. But I would stress one thing which is that, you know, some of these reforms are of course quite structural. They will take a while to play out, especially the GST. I would not underestimate the importance of the insolvency and bankruptcy code. I think being able to take a bankrupt company and resolve it within 270 days is actually if we can deliver on this, we would actually have a faster bankruptcy code than many developed countries in the world. I think this could stimulate the market for corporate bonds in our economy. It would reduce the reliance on banks for financing, especially from large corporations for infrastructure investments, et cetera. And third, I think the recapitalization of banks that's been announced, I think the plan is to also reform the public sector banks at the same time. And we are hoping that the confluence of many of these structural factors along with a better monetary transmission can actually deliver well on what has already been pushed through. I would just mention one thing, which is that, as I said right at the beginning in the technical jargon piece, the central bank's monetary policies mandate is to achieve over medium term the target inflation rate of 4%. And, you know, the recent inflation prints have been in that zone. There is some mounting pressure through oil prices in the economy as well. And so these are all factors that the monetary policy has to take into account while at the same time as our mandate says keeping in mind the objective of growth. So, you know, that's a difficult tradeoff. It's a little hard for me to resolve it myself and also before the monetary policy meeting takes place. So you have to wait for 2.30 p.m. on one of the Wednesdays and first weekend of the first Wednesday of December, I think. So, just one more question. I think let's give someone else a chance and then if there's time, we can rotate. Yes, please. Hi, I'm Shridhita Maithi. I'm a scientist at TIFR and don't understand economics at all. I have a very simple question. Price, rise or inflation or deflation, I can understand when it depends on demand and supply. Some year we have a lot of production of wheat. Not so many people to consume it. The price goes down. Opposite happens when some other years there is not. That you sitting in a room in Bombay can dial up something called the repo rate and determine these rates seems like voodoo to me. I mean, how does it work or should it even work? So, you like the answer I gave my mother-in-law. It's just a fidget toy. I think it's exactly the sort of question I think that should be asked. I think this is exactly the question I've tried to ask with my research, which is does it really work? When does it work and when does it not work? And I think the answer is the following, which is that, you know, if you just think about it simplistically, suppose tomorrow we reduce the rates to extremely low levels and suppose the deposit rates were actually floating, as I mentioned, we wanted to make them to be. I'm just giving one scenario in which things could change very quickly. Then, you know, you and I will not want to park our money in deposits. We will say I'm not earning anything. Let me go and buy higher-yielding assets. What will be higher-yielding assets? They are the risky investments in the economy. Maybe it's going into an equity mutual fund. Maybe it is saying, oh, you know, the insurance guy who kept knocking on my door, maybe it's time to finally let him in and see what policy and return he has to offer. And maybe over a long period of time I can lock in a return because, you know, the central bank is killing the hell out of my deposit rates. Now, all of that allocation that goes to risky investments will then, through improvement in prices, et cetera, will make it advantageous for these firms to invest more. So then, you know, in a quarter's time when the savings reallocate, the companies will see that their prices are going up. This is a good time to raise equity in the market. Or they will see that insurance companies are willing to buy their 10-year or 15-year bonds at much lower interest rates than before because they are getting flooded with people interested in policies with them. And they have to deploy these premiums that they are collecting to use. So these companies will say, let's go and float some bonds in the market. Maybe they will go and approach banks which, on the one hand, are experiencing deposit outflows. But on the other hand, whatever deposits are staying with them, their cost is also very low. So they can afford to actually even bring down loan rates to bring some of the lending back to them. So now once these, if this happens, then the firms will start investing. Now, as they start investing, they will need to hire labor. They may have to import more oil. They may have to buy more raw materials. Unless all of that, supply of all of that adjusts instantaneously, the price of labor will go up. Price of oil will go up. That's just now a demand effect, assuming that the supply is not fully offsetting it. So on the one hand, economic activity will pick up, but as they sometimes say, the economy will also get heated. The prices will start rising because as the price rises, I know that there is a lot of jobs available. A lot of people are posting advertisements. My wage expectations will rise. So if I have to move to another firm, I will say, yes, I'll do so, but you need to give me a 10% pay rise over the next year. Only then I will come in. So I think you're absolutely right that a lot has to work for that dial from one office in the central bank to actually then act as a lever that's going to pull up the entire economy. And I think your question is exactly the right. One has to be really sure that the initial conditions of your banking system, the way they are setting interest rates on deposits, the way they are setting interest rates on loans, your markets, the way the health of your companies, the ability of your banks to lend and take some risks that all of these are in structurally in place so that that dial can actually be a powerful tool. If not, as I was saying, things may get wasted. You may get some pass through here, but nothing is happening there. You know, so if deposit rates get reduced, but there is no reduction in loan rates, then the savers didn't get the benefit. The borrowers didn't get the benefit. It's the intermediary who pocketed a margin in between. Maybe they are doing it because they are trying to fix their balance sheet because of past losses. But it's important to understand what these frictions are because if you understand the frictions, you can identify what are the right remedies. But I would encourage everyone to ask exactly the question that you posed, which is basically question fundamentally, why would what I'm doing in the central bank or what other central banks are doing would actually reach any one of us in the first place? Sir, good afternoon. Hi. I'm Saurabh Mittal. I'm an investment advisor. I just wanted to ask you that you said that the banks have given the option to use either an internal or an external benchmark for deciding the mortgage loan. So one is that I understand that there are few banks who are following both the benchmark simultaneously. For some customers, they are using an internal benchmark. And for some customers, they are using an external benchmark. So if a customer is offered an external benchmark, can you shift back to the internal benchmark later on? That's one question. And second is why is it, what are the challenges that RBI is facing to make it more mandatory to use an external benchmark? And because I believe that that would be a popular system elsewhere also because as you rightly said, it's more transparent. So I think the first point is right, which is what happens is, and this was coming back to the last part of the concluding sentences I said, which is that some borrowers will have better ability to manage interest rate risk fluctuations than others. A homeowner will not be able to do that as well as a large industrial house in the economy because they will have a treasury operation and they will try to manage the interest rate risk as it fluctuates on their loan in some way. So it could be that the banks are essentially just catering to the sophistication of their borrower through the benchmark. What would it take for us to move to an external benchmark? I think first we have to carefully evaluate all the feedback that we are having. As I was just responding in the first question, there is some important shocks that the economy is actually coming out of several structural reforms are taking place. We want to ensure that the rollout of the external benchmark setting process is at a time when again some additional frictions in implementing something new can be absorbed well by the system. We don't want to necessarily add one more uncertainty or noise in the mix at this point. So I think we have to carefully think about the right transition path to where we want to be. The study group suggestions are of course very clear as I mentioned. Okay. Thank you very much for being a patient and at least for those of you who have managed to sit through for also being a persistent audience. Thank you very much. Please join us for tea outside the auditorium.