Sonalika Sinha (Reserve Bank of India): Effectiveness of macroprudential regulations and capital controls – Evidence from India

BOFIT Seminar - Sonalika Sinha (Reserve Bank of India): Effectiveness of macroprudential regulations and capital controls – Evidence from India

Abstract

This study investigates how regulatory macroprudential and capital flow interventions transmit to bank and firm lending. The analysis employs a fixed-effect panel methodology to estimate changes in loan supply in response to prudential interventions enacted by Reserve Bank of India between 2002-2019. The study constructs a unique prudential database documenting a timeline of sector-wise macroprudential tools like risk weights, provisional limits and restrictions on external capital flows such as limits on foreign portfolio investments and external commercial borrowings. Results indicate that in response to a tightening prudential announcement in a specific sector, banks reduce their aggregate loan supply within one to two quarters, as they are unable to quickly switch lending to other sectors, thereby cutting into their aggregate loan portfolio. Bank responsiveness to prudential regulation is driven by two main characteristics i.e. bank ex-ante capitalisation and size. Banks with inadequate margin capital are more responsive to prudential tightening, as compared to banks with adequate ex-ante capitalisation. Further, the interaction of monetary policy and macroprudential tools tends to be complementary, although macroprudential policies are typically quicker to transmit to bank lending channel. Tightening prudential regulations also leads to a cleansing effect at the firm level, as banks cut lending to less solvent and less liquid firms, thereby weeding out low-quality borrowers. While these effects are more pronounced in the short term, macroprudential tools in India have achieved their intended regulatory consequence. This research provides a publicly available dataset and index of sector-wise macroprudential regulations and capital flow measures in India, which enables an intensity-based policy impact assessment.

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