Higher Bank Credit May Not Always Lead to Higher Investment

Mumbai: Increase in credit from banks may not always lead to a rise in investments as largely anticipated, said an RBI working paper.

The analysis shows that in the banking sector, partial monetary policy transmission happens with a lag. Further, banks respond to changes in money market spreads faster and better than changes in policy rate.

The working paper titled 'Monetary Policy Transmission in India: New Evidence from Firm-Bank Matched Data' noted that quick and significant bank loan expansion resulted from a change in term spread.

Citing its analysis, the paper said: "We show that in addition to slow or lagged monetary policy transmission, an increase in credit may not always find its way towards increasing investments."

It added that firms may use their credit lines to finance their current liabilities rather than undertaking capital formation.

The RBI working paper said that in some cases at the firm level, counter-intuitive results were witnessed due to a change in monetary policy on the firm's balance sheet.

"This may be because firm's investment decisions may be correlated with the demand conditions in the economy, which may in turn be correlated with the monetary policy cycle. Thus, the effect of monetary policy that we estimate on firms may not reflect the true effect of the policy itself," it said.

RBI Working Papers present research work of the central bank's staff members. The reseach is further disseminated for comments and further debate.