To Lower Cost of Credit, Track Information Asymmetries, Pg12

Key Highlights:

• The Reserve Bank of India (RBI) kept interest rates on hold at its Monetary Policy Committee (MPC) meeting on August 5.
• This decision results in negative real interest rates, aiming to boost credit supply, consumption, and investment.
• The RBI expects inflation to reach 5.9 percent in Q3-FY27.
• There is a concern that prolonged low real rates could encourage risk-taking by banks, potentially leading to higher Non-Performing Assets (NPAs).
• The article suggests that reducing information asymmetry costs through digital public infrastructure is a more efficient way to lower the cost of credit.

Detailed Insights:

• The current negative real rates are significantly lower compared to the 2 percent-plus real rates observed during 2016-2018.
• Credit to the small and medium sector and retail segments has shown strong recovery since Q4-2025, coinciding with falling expected real rates.
• Research indicates that extended periods of low real rates can induce weaker banks to approve riskier borrowers and require less collateral.
• Lower real lending rates can compress banks’ profitability, incentivizing them to search for higher-yielding, riskier borrowers.
• Reduced profitability also diminishes banks' incentive to screen and monitor borrowers effectively, contributing to increased risky lending.
• India's experience during the first half of the 2010s, with low real rates, contributed to a full-blown NPA crisis.
• The National Payments Corporation of India (NPCI) transformed digital payments, creating a financial trail that lowered information asymmetry and lending costs.
• The RBI's Unified Lending Interface is an initiative designed to build upon this digital infrastructure to improve credit intermediation.
• Better financial intermediation makes good borrowing cheaper by efficiently identifying creditworthy borrowers, unlike low interest rates which make all borrowing cheaper.

Key Concepts Involved:

• Real Interest Rate: The nominal interest rate minus the inflation rate, reflecting the true cost of borrowing or return on saving.
• Information Asymmetry: A situation where one party in a transaction has more or better information than the other, leading to potential market inefficiencies.
• Non-Performing Assets (NPAs): Loans or advances for which the principal or interest payment remained overdue for a period of 90 days.
• Monetary Policy Committee (MPC): A body in the RBI responsible for formulating monetary policy to achieve inflation targets and support economic growth.