Cash Reserve Ratio

Of late we have been hearing about the ongoing debate in the Indian economy pertaining to CRR.

One of the best suggestions recently came from the Chairman of the Prime Minister’s Economic Advisory Council, C. Rangarajan.

Mr. Rangarajan suggested on phasing out the cash reserve ratio (CRR) requirements of banks and using this measure of credit control “only in extraordinary circumstances”

What is Cash Reserve Ratio (CRR) and its Uses

Before we go deep into the matter, let’s see what is CRR all about? And what are its uses, impacts, etc.

CRR or the Cash Reserve Ratio is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. These required reserves are normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.

If we talk about the Indian economy, currently, for every Rs 100 of deposits banks receive, they have to keep Rs 4.75 with the Reserve Bank of India (RBI), the central bank of India, which in turn does not pay the commercial banks any interest on this impounded money. For many, CRR is a tool for sucking out a portion of deposits kept with banks that they would ordinarily have lent out and earned interest income but due to regulatory norms laid by the central bank, is nothing but poor cash lying uselessly in the Central Bank’s vault.

Role of Cash Reserve Ratio

It is believed that instrument like CRR may have been in tune with the philosophy of financial repression underpinning the conduct of monetary policy of the pre-nineties which was a period of administered deposit and lending rates, where RBI had to compulsorily fund the Government by subscribing to the latter’s bonds, selective credit controls and so on. The period was a regime characterized by fiats of all manner and kind. For many, CRR was an imposition on the commercial banks operating in the economy for the purpose of controlling credit default and creation was perfectly in accord with the regulation and culture which prevailed in yesteryear of Nineties.

If we look into today’s scenario, we find just the opposite. Indian economy along with the global economy is becoming highly globalized, integrated, interrelated, where interest rates are predominantly market-determined and there is also no automatic monetization of budget deficits.

The central bank controls the supply of money and can increase or decrease the same by buying and selling bonds through open market operations which is undertaken independently.

RBI can also influence interest rates, by raising or reducing the ‘repo’ and ‘reverse repo’ rates at which the commercial banks borrow from or park money with it. Thus with such superior monetary policy options which  is available today, in sync with the current regulatory philosophy CRR is thought of an anachronism that ought to be dispensed with, or used in “extraordinary circumstances” only as cited by Rangarajan.

CRR in Stressful times & Today

It is argued that in the year 2007-2008 when the country was inundated by over $100 billion of capital flows, which resulted in unprecedented challenges to domestic liquidity management, CRR modifications made sense. On the contrary to the year 2007-08 we are in a much better state today and there is hardly any need for such options now.  Today when the forex inflows have moderated considerably and firms are battling liquidity constraints we have least requirement of mandatory CRR requirements.

Rangarajan who himself is a former RBI Governor, favored doing away with the CRR. According to him now is the time to make a start. By neither reducing the CRR nor the repo rate, the RBI has made it difficult for banks to bring down their cost of funds, without which  lowering the lending rates is becoming a tough task for the banks and thus disbursement of the loans to the common man is reducing considerably. In such a situation the only way out is to reduce deposit rates which are recently adopted by the India’s largest bank, the State Bank of India (SBI). Seeing SBI many other banks have followed the same policy and have reduced the deposit rate.

SBI Chairman, Mr. Pratip Chaudhuri, defended the move of CRR by citing poor credit demand. He said, “When there are few takers for loans at current rates, there is no point attracting deposits that needs to be invested in bonds or, worse, impounded as CRR earning zero interest?”

  It is also seen in the current fiscal that the investments in government securities by banks have increased heavily and is recorded at Rs 192,900 Crore. Thus it is not wrong to say that whichever way one looks at it, the case for abolishing the CRR if not cutting the repo rate cannot be stronger. Now the time has come that RBI need to act in favor of the banks lowering the CRR if not slashing entirely so as to boost a growth in the economy and the financial market.

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