Friday, September 14, 2012

Has CRR outlived its utility?

Every commercial bank in India has to maintain a certain percentage (presently 4.75 per cent) of its Net Demand and Time Liabilities (NBTL) as CRR (Cash Reserve Ratio) with the RBI. This is mandated by the RBI which is the banking regulator in the country.

CRR is a time-tested policy instrument of the RBI on which no interest is paid by the regulator.

Now, the Chief of SBI, the leading commercial bank in India has opined that some reasonable return, read interest, be paid by RBI.  The immediate response of the Apex bank's Deputy Director is not just outright refusal but not in good taste, too. Instead of yielding to at least examine the issue threadbare, he has rebuked the chief of SBI.

As a policy instrument, the CRR is used to serve two objectives - to ensure solvency of banks and manage monetary policy. With just 4.75 per cent of NDTL, there is no way solvency of banks is guaranteed viewed especially in the context of financial crisis. Further, CRR is not used in all countries of the world and is therefore nothing sacrosanct about it. It is now realised that the supervisory oversight of the Regulator is more important to avert disasters such as bank failures.

The second argument for use of CRR is to manage the monetary policy which is the basic responsibility of the Central Bank. In mature economies, major role of the regulator is only to manage inflation; in developing economies, it is meeting dual objectives of growth and restricting inflation. By adjusting the rate of CRR, the intention is to either enhance or curb liquidity. Of course, this is one of the policy instruments. The RBI could also use Open Market Operations (OMO) to adjust liquidity in the market. However, it is easier for the RBI to infuse liquidity in the system; at times, it may not be easy to curb it if banks show reluctance to buy Government paper.

Commercial banks feel that CRR constrains them. Presently the equation is like this: out of ` 100 deposit, SLR (Statutory Liquidity Ratio) takes away ` 22.5, CRR another ` 4.75 and banks have to set aside ` 40 towards priority sector. This leaves just around ` 43 for commercial and profitable lending.

Priority sector lending is mandated by the Government, too. In any case, banks' longer-term interests are also intertwined with financial inclusion and inclusive growth of the economy. Nor can banks have any quarrel with SLR. Presently banks together have around 28 per cent of their NDTL in Government paper. Sluggish growth of the economy has meant there are fewer buyers and higher risks in lending.

On a rough reckoning, ` 3.25 lakh crore is locked up in CRR. As far as banks are concerned this is what the RBI has impounded without paying a penny as interest. In a way, this is also a NPA (Non Performing Asset) even when NPAs in real world are on the rise. Even a 1 per cent interest payment by RBI would give out ` 3,250 crore to the banking system; this would improve the profits of banks by 4.5 per cent! At a time when several banks are struggling to shore up their bottom line, this would be a real boost.

The other option for RBI is to use repo and reverse repo rate instead. But experience shows that interest rate adjustment is only indicative of what the RBI wants. It will   impact profits of only those banks which use the RBI's window for repo. On the other hand, CRR hike or reduction has immediate effect, for it immediately impounds or releases liquidity in the system.

 CRR is a quantitative measure and is not efficient. With more stringent Basel norms coming sooner or later, efficacy of CRR is bound to be questioned. However, presently the RBI's comfort is in keeping intact CRR. In that case, it would be only proper that a via media needs to be found. Probably answer lies in both lowering CRR gradually and similarly start paying interest and increasing the same to around 3 to 3.5 per cent in a phased manner. This way, the RBI will not be overburdened and at the same time banks will be getting higher amounts for commercial lending.

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