RBI

The subject of asset liability management is of relatively recent origin both internationally and, more so, in India. This is the first of a series of articles which will discuss the different issues involved, critically examine the maturity gap model, suggest alternatives, look at the principles of pricing deposits and advances and deal with connected subjects.

While the rationale for raising the interest rate to defend an exchange rate under speculative attack is well grounded in economic and financial theories, empirical validation of the effectiveness of such a policy stance has generally been difficult and is shrouded with conflicting findings. In India, besides forex market interventions and use of several administrative measures, the Reserve Bank of India has occasionally resorted to the high interest rate option during major episodes of significant pressures on the external value of the rupee. An empirical assessment suggests that one standard deviation shock to the call rate leads to rupee appreciation in the very second month. Similarly, for one standard deviation shock to net interventions, the exchange rate appreciates gradually by a few paise over five months. The impulse response also suggests that in response to one standard deviation shock the exchange rate appreciates by about 8 paise in the second month, but subsequently the exchange rate depreciates gradually, more than offsetting the initial impact of the hike in interest rate.

The mid-term review of the monetary and credit policy for the current year springs no major surprises. It has, in the main, lowered the Bank rate by 50 basis points to 6.5 per cent and proposes to bring down, over the next two months, the cash reserve ratio to 5.5 per cent from the current effective rate (taking into account various exemptions and variable reserve ratios for particular segments of liabilities) of 6.3 per cent for the banking system as a whole. It has made further refinements of the various processes of strengthening prudential regulation of the banking system. More pertinently, it serves to highlight the constraints within which monetary policy operates in India, even going to the extent of drawing explicit reference to some of the structural impediments arising from government policy.

The purpose of this paper is to examine the choice of location of prudential supervision of banks. Should central banks assume this role or should there be a unified regulator covering all financial institutions? With the growing concern among central banks about the need to maintain financial stability, can such problems be effectively tackled if regulation/ supervision is vested with the central banks? The evidence.