Cash Reserve Ratio Issue Final

CRR Issue and the Follow ups:

Initial Statement of SBI Chief:

SBI chief for phasing out of CRR :

The system of cash reserve ratio should be phased out as the original reasoning behind the cash reserve ratio has been diluted over time, State Bank of India Chairman Pratip Chaudhuri said here on Thursday. “There were compelling reasons to have a re-look at CRR as a policy instrument. In effect, the CRR policy has possibly denied the country growth, income and taxes,” he said.

Speaking at the FICCI Banking conclave here on Thursday, the chief of the country’s largest banker urged industry bodies such as FICCI to pursue the matter, as a phasing out of CRR would allow banks to lower lending rates thus helping industry.

Section 42 of the RBI Act authorises the central bank to notify the quantum of the cash reserve ratio to be maintained by the scheduled bank by way of a deposit with the RBI.

The provision has served the twin purpose of impounding resources to curb speculative lending and ensuring liquidity reserve for banks and is also used as a tool to control inflation.

“It is not my case that CRR be abolished entirely tomorrow. However it does need to be phased out within a reasonable period of time,” he said. He further said that huge amount of fund could be unlocked in this manner.

“The lack of capital constrains banks from expanding their balance sheets. But for this constraint on capital, the Indian banking system would have been 25 per cent larger, and, as a corollary the Indian economy too would have been 25 per cent bigger”, Mr Chaudhri said.

He later told reporters that the matter was being pursued with the central bank.SLR securities were adequate as a solvency and liquidity reserve and additional pre-emption towards CRR was largely superfluous, according to Mr. Chaudhuri. If the CRR was a liquidity mop-up tool, then it should be applied to insurance companies, NBFCs and debt mutual funds.

Responding to question as to whether he would favour a lowered rate of both CRR and SLR, the SBI Chief said: “I prefer abolition of CRR rather than reduction of rates of CRR and SLR—the impounded CRR amount stays sterilised in vault. In case of SLR, we get some return at least”, he said.

RBI slams SBI on CRR issue:

Chennai, Aug 27 (TruthDive): RBI Deputy Governor, K.C. Chakrabarty slammed SBI Chairman, Pratip Chaudhuri’s statement on phasing out of cash reserve ratio (CRR). He said SBI should either comply with or do business elsewhere.

Organised here by Great Lakes Institute of Managemet a financial conference on systemic risk the RBI Deputy Governor, K.C. Chakrabarty, said SBI must work within the framework prescribed by the regulator.

The SBI Chairman asked how CRR help anybody when it is not applied to insurance companies, NBFCs and mutual funds that are also in the business of collecting deposits from the public. It is unfair to put it on banks.

CRR is reserve fund used as safety by RBI. Chakrabarty said it was like a tree catching fire, which will spread across the forest, SBI is too big to fail and if it is not protected, the risk may spread to other banks and in turn leading to a systemic failure.

Currently, 4.75 per cent of total bank deposits are kept with the Reserve Bank of India. Banks earn no interest on such funds. Pratip Chaudhuri said has lost much of its validity now as it pushes up the cost of funds for industry.

Chauduri was speaking at the Federation of Indian Chambers of Commerce and Industry conference in Kolkata. To make up for the loss of interest on CRR of 4.75 per cent which doesn’t earn any income, then balance resources will have to earn for the rest leading to a cost increase for the industry without benefiting anybody.

Chauduri said that CRR be abolished need to be phased out within a reasonable time-frame as release this large quantum of money in a capital starved economy with requirement for infrastructure could be used.

Chaudhuri said CRR deposits was close to Rs 21,000 crore and SBI share was close to Rs 3,500 crore, he said. CRR was largely superfluous when SLR deposits were sufficient to take care of the issues of solvency and liquidity. RBI should consider paying interest corresponds to the savings bank rate he said.

CRR is a cost, manage it: Chakrabarty tells SBI:

That is what the law also says, explains RBI Deputy Governor

Work within the rules laid down by the regulator. If you can’t, you better find a different avenue where you can do your business, says K. C. Chakrabarty, Deputy Governor of Reserve Bank of India.

He was reacting to a question on the suggestion made by State Bank of India Chairman Pratip K. Chaudhuri to abolish CRR (cash reserve ratio).

“From State Bank point of view, they can ask for abolition of CRR, SLR (statutory liquidity ratio). But, we have to function within the regulatory system in which you are in. If you are not able to do business in the regulatory system in which you are functioning… you will have to find out something else … where you can do business,” Dr. Chakrabarty said in an interaction with The Hindu here on Monday.

Quizzed further, he said, “No, I am not angry [with SBI chairman].’’ In this context, he cited the example of bargaining with a vendor of potatoes in the marketplace. While the vendor quoted Rs.10 a kg, the buyer quoted Rs.3 a kg. “But the fellow [seller] does not agree. So, the deal does not take place.”

The RBI Deputy Governor asked: “What is the regulatory system for? Whether to reduce it [CRR] to zero or increase it, the regulator had the right to decide.”

Asked if the Reserve Bank would seek the opinion of banks on this issue, he said, “Why should I take others’ opinion. My regulatory system is not based on what the opinion of other people is.” When pointed out that many countries did not have CRR, he said, “several countries are not having. But several others are having.

It is the job of Reserve Bank to decide. Anybody who has to do the business has to do it within the regulatory environment which has been provided.”

The SBI Chairman sought the abolition of CRR on the ground that it did not earn any interest for the banks.

“That is what CRR is meant for,” Dr. Chakrabarty said, pointing out “that is also what the law says.” The RBI, he explained, had no role to play in this. “The Banking Regulation Act says you cannot pay interest on the CRR. The matter is over. If law says certain things, it is like that.”

“If you feel [that RBI decision is an irritant], then pay little bit less interest rate on deposit or charge more interest on loans. How much difference does it make? Regulatory things are your production cost. So, you have to accordingly adjust your pricing,’’ he added.

CRR issue: After the RBI snub, comes the SBI rebuttalAugust 29, 2012 10:46 IST

State Bank of India Chairman Pratip Chaudhuri on Tuesday took a gentle dig at the Reserve Bank of India Deputy Governor K C Chakrabarty, who hadadvised him on Monday to 'find out some other place' if he didn't agree with the current regulatory environment insofar as cash reserve ratio was concerned.

Speaking on the sidelines of an investor conference on Tuesday, Chaudhuri said he hadn't read the complete media reports, but what he remembered was that Chakrabarty had the same views when he was a banker.

"What I want to say is that it's just a view.

"When he (Chakrabarty) was a bank chairman, he was also of the same view (reducing the CRR)," Chaudhuri said.

He made the remarks with a big smile, but the message was loud and clear.

Before joining the central bank, Chakrabarty was the chairman and managing director of Punjab National Bank [and before that, of Indian Bank

However, while speaking to NewsWire 18, Chaudhuri clarified his intention was not a complete abolition of cash reserve ratio overnight, but to ignite a public debate on the merits of CRR.

"My comments are in sync with the views of most of the bankers today," he said.

Chaudhuri had earlier suggested that CRR should be phased out in a time bound manner or at least RBI should consider a paying an interest on it equivalent to the savings bank account rate if not the repo or the reverse repo rate.

CRR is the proportion of deposits that banks need to park with the regulator.

While RBI used to pay interest on CRR funds, but that system was withdrawn a few years back.

As a result, banks do not earn anything for keeping CRR with RBI but the negative carry for CRR and also SLR (statutory liquidity ratio) is considered while calculating the benchmark lending rate -- the Base rate.

At present, CRR is 4.75 per cent.

The central bank had reduced CRR by 125 bps to improve liquidity situation during January-February. CRR is not only used a liquidity tool but also indicates the monetary policy stance of the central bank.

Capital infusion:

Regarding fund raising, Chaudhuri said SBI was in talks with the government for capital infusion and he expected the government to infuse about Rs 4,000 crore (Rs 40 billion) this financial year in the bank.

The government is committed to infuse capital in the PSBs and retain its stake, financial services secretary D K Mittal had told reporters on a sidelines of an event last year in Mumbai.

However the Rs 8,000-crore (Rs 80-billion) capital infusion for SBI came only at the end of the last financial year after from the government after dilly-dallying on the issue for the whole year.

Capital adequacy ratio for the SBI at the end of the first quarter stood at 13.17 per cent.

SBI chief for a national debate on CRR:

State Bank of India (SBI) Chairman Pratip Chaudhuri, on Monday, reiterated his stance on Cash Reserve Ratio (CRR) that it should be phased out completely and wanted a debate on the subject.

Mr. Chaudhuri first made this suggestion for CRR phase-out in Kolkata a few days ago. However, the Reserve Bank of India (RBI) Deputy Governor K. C. Chakrabarty, in an interaction with The Hindu recently felt that banks had to work within the rules laid down by the regulator.

“If you are not able to do business in the regulatory system in which you are functioning… you will have to find out something else … where you can do business,’’ he had said.

Demanding a national debate on the subject, Mr. Chaudhuri said that nobody was giving any reason why it could not be abolished. He was talking to journalists at a press conference to announce a two-day annual conference on ‘Global banking: paradigm shift’ being organised by FICCI and Indian Banks’ Association (IBA) on September 4 and 5 here.

Mr. Chaudhuri had reportedly stated in Kolkata that parking the mandatory funds (CRR) with the RBI without any interest on it was a heavy loss for banks. Banks are required to keep 4.75 per cent of their deposits with the RBI as CRR.

Mr. Chaudhuri said that banks needed a level-playing field as insurance companies and non-banking finance companies (NBFCs) were not required to keep such mandatory funds with regulators.

Cash Reserve Ratio (CRR) Dilemma: To

Abolish Or Not?

New Delhi (CapitalTrends): Cash Reserve Ratio is back in the news

again. This time CRR is not making news because of any rate cut or

liquidity issues. The recent public spat between RBI deputy governor KC

Chakrabarty and State Bank of India (SBI) chairman Pratip Chaudhuri on

the issue of the relevance of Cash Reserve Ratio (CRR) has attracted

public attention.

CRR is a portion of the deposits that banks are required to keep with the

central bank. It is currently pegged at 4.75% of the total deposits and such

deposits do not earn any interest from RBI.

The controversy regarding the CRR was fanned by comments of State

Bank of India Chairman, calling for abolishing the mandatory Cash

Reserve Ratio. According to him, CRR was meant for preventing banks

from going into insolvency. But if Statutory Liquidity Ratio (SLR) which

is presently at 23%, is not accessible for raising loan, then it implies that

CRR which is at 4.75%, won’t help.  These views invited sharp reaction

from RBI Deputy Governor K C Chakrabarty.

CRR has been used as one of the several key monetary tools which give

the Reserve Bank to maintain the liquidity level in the economy. It helps

RBI to drain excess liquidity to rein in high inflationary situation and also

helps to inject liquidity in the other case.

CRR along with helping the banks, also aids government with

considerable liquidity for managing its finances. And this is where the

controversy arises. The advocates of CRR abolishment hold the view that

the cash reserves must be maintained for prudential purpose, not for

funding government debt.  And they have also called for a reasonable

interest, say 7% to be included with the CRR.  And many of them even

think that the CRR is adding cost to the economy.

Consequent to the amendment in July, 2006, RBI stopped paying interest

to banks on their CRR deposits in 2007. Banking industry has locked up

around 18 lakh crores in both the CRR and SLR. If these rates are lowered

then it may provide cushion to the private entrepreneurs, in turn reducing

the cost of funds.

According to Assocham – “Continuation of interest free cash reserve ratio

(CRR) by RBI is for a healthy and effective direct monetary and indirect

liquidity management as well as provide a big cushion in difficult times,

consequent to a debate that is taking place to undermine the efficacy of

CRR in present times.”  In other words, CRR as a monetary tool enhances

RBI’s operational flexibility and greater maneuverability in monetary

management.

The debate has gained momentum not only in the banking industry but

across other financial institutions. Hope, this debate helps the banking

industry and the Indian economy to achieve new and appreciable heights

in the near future.

.Economists Views:

CRR abolition comment: ICICI Bank

chairman KV Kamath disagrees with SBI

ChairmanICICI Bank Chairman K V Kamath on Thursday disagreed with the suggestion of SBI

chief Pratip Chaudhuri that RBI should scrap CRR, saying it is part of the monetary

policy and no issue can be made of it.

Asked to comment on the vocal slugfest between Chaudhuri and RBI Deputy Governor K

C Chakrabarty on the topic, Kamath said in the whole issue of monetary policy , several

tools are being used, including Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio.

CRR is the portion of deposits kept by banks with the Reserve Bank on which no

interest is paid.

"I think the monetary authority (RBI) in its wisdom uses all these tools as appropriate and

that's what is being done.

This (CRR) is nothing new. India always had a CRR for as long as I can remember and I

don't think honestly (there is) an issue to be made here", he said.

"You should look at it (CRR) as part of monetary policy that it is exercised and part of it

is liquidity policy for the banks", added Kamath, also non-executive Chairman of Infosys

Ltd. Earlier, he addressed the eighth India Innovation Summit, organised by CII.

Last week, Chaudhuri made a strong pitch for the abolition of CRR, saying that keeping

required funds with the Reserve Bank without any interest was costing the banking

system about Rs 21,000 crore.

He called for phasing out of CRR, saying it would allow banks to lower lending rates. If

the RBI can't do away with it, it should at least pay some interest on CRR since banks pay

their depositors, he had said.

Chaudhuri had also contended that "the CRR policy has possibly denied the country

growth, income and employment", and argued that since RBI does not pay any interest on

CRR, this acts as a tax on the banking system.

Chakrabarty had this week frowned on Chaudhuri's contention on phasing out CRR. "If

the SBI chairman is not able to do business as per our regulatory environment, he has to

find some other place," he had said.

Dr.C.Rangarajan’s Views:

The country needs to move towards a situation where Cash Reserve Ratio (CRR) level comes down and that it is used as an instrument of “credit control” only in extraordinary conditions, said C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, on Thursday.

As “Open market operations (OMOs) became increasingly major instrument….The role of CRR, as credit control, will come down,” said Dr. Rangarajan while talking to presspersons on the sidelines of the FICCI-IBA banking conference here.

CRR is the proportion of deposits banks must set aside with the Reserve Bank of India (RBI).

Last month, State Bank of India had sought scrapping of CRR, which stands at 4.75 per cent.

While talking on CRR as a monetary instrument, he said that prior to 1991 CRR was the major instrument of credit control because interest rate was administered and, therefore, OMOs could not be conducted and, therefore, CRR remained the major or the only instrument of credit control available with the RBI.

In fact, at that time, CRR continued to be raised to very high levels because the budget deficits were high and it was being financed by the RBI and, therefore, to contain liquidity growth, CRR needed to be raised to very high levels.

However, said Dr. Rangarajan, “at the time of the banking sector reforms, we took a conscious view to reduce the CRR and, therefore, it has been progressively brought down.”

While speaking on the topic ‘The Indian banking system — some issues’, Dr. Rangarajan said that if the Indian banking system was to remain competitive over time, there should be periodic entry of new banks . “A closed system can only become oligopolistic. The ‘threat’ of entry should not, therefore, be eliminated, and the central bank should lay down entry norms as also decide on who satisfies the criterion of fit and proper,’’ he said

“It must be noted that new banks take about two decades to achieve a sizable level”, said Dr. Rangarajan, adding, “Our decision on how many new banks to be licensed must be based on what the economy will need - not today but over the next several decades.” Further, he said that banks needed to watch out for liquidity risks which would increase because of maturity mismatches. “Increased exposure to real estate and infrastructure will lengthen the maturity of bank assets.” He said that Indian banking system was also exposed in a big way to certain sectors such as power and aviation which were not doing well.

“The challenge for banks lies in efficiently managing risks both in the upswing and downswing.”

Columnist Views:

CRR’s relevance should not be overlooked

AMARESH SAMANTARAYA

September 7, 2012:  

Recently, a debate has resurfaced on the relevance of the cash reserve ratio (CRR) as a monetary

policy instrument. It began with the suggestion of the SBI Chairman, Pratip Chaudhuri, to phase

out CRR and pay interest on impounded funds under CRR, till it is phased out. He has pointed

out that as CRR deposits do not earn income, the loss to the banking industry is close to Rs

21,000 crore on this account.

In his opinion, this is leading to a cost increase in the banking industry without benefiting anyone.

How the SBI Chairman evaluated the benefits of CRR in order to arrive at such a conclusion, is

not clear. But there can be no denying that if the RBI agrees to his suggestion, it will boost the

bottomline of his bank. There are two critical issues to be considered here.

INTEREST ON CRR BALANCES

It is obvious that if the RBI pays interest to banks on CRR balances, any increase in CRR as well

as expansion in bank deposits, which forms the basis for CRR, will be taxing for the RBI.

In his article “An MRI on health of the economy” (Business Line, September 7) noted economist

and former RBI Deputy Governor S. S. Tarapore has already explained this aspect. He had shown

how payment of interest on CRR would make it ineffective as a monetary policy instrument.

There could be situations when interest payments will exceed incremental funds impounded

through CRR in a year, and overtime, the spiralling effect will damage the RBI’s balance-sheet.

Moreover, the prevailing fiscal position of the Government also warrants not paying interest on

CRR balances. If the RBI is saving Rs 21,000 crore as suggested by Chaudhuri, the entire amount

will be transferred to the Government as part of the RBI’s profit.

On the contrary, if the RBI pays interest to banks on CRR balances, only a part of Rs 21,000

crore which accrues to public sector banks will be transferred to the Government, while a portion

will be reflected in profits of private and foreign banks. Obviously, the former is consistent with

the Government’s goal of reducing fiscal deficit.

The RBI itself has contemplated reduction of CRR to its statutory minimum since the late 1990s,

as part of rationalisation of CRR with a medium-term perspective. This has been documented in

various RBI policy documents.

PHASING OUT OF CRR

In the process, CRR was reduced gradually from 11 per cent in August 1998 to 4.5 per cent in

June 2003. Subsequently, with apparent signs of overheating of the economy, CRR was

increased.

The CRR is a very effective instrument for monetary tightening, apart from providing a liquidity

cushion to banks. It can also play a very helpful role for open market operations of the RBI by

ensuring a predictable demand for RBI balances.

Of course, its disadvantage is that it stifles all types of credit expansion, both desirable and

undesirable. There is also a cost to the banks as CRR balances do not earn interest, as suggested

by the SBI Chairman.

On balance, the RBI is in a better position to judge the suitability and relevance of CRR.

In this regard, it is obvious that commercial considerations will influence the opinion of the SBI

Chairman. As rightly noted by K. C. Chakrabarty, RBI Deputy Governor, in the interest of

economic and financial stability, CRR is an important regulatory instrument.

If the SBI Chairman wants to expand credit at a cheaper lending rate, SBI can do so as a market

leader, by cutting both its lending and deposit rates.

CRR has outlived utilitySeptember 9, 2012:  

An interesting debate on CRR has been initiated by State Bank of India (SBI) Chairman

Pratip Chaudhuri. But the response of Reserve Bank Deputy Governor K C Chakrabarty to

the debate was rather uncharitable. In fact, the remarks of the Chairman of India’s largest and

oldest bank on the issue of CRR deserve to be taken seriously.

The CRR mechanism had lost its relevance as a monetary tool in post reforms and post-

technology (or ‘core banking solutions’) banking. With latest management information

system tools, the RBI is able to get the requisite banking figures more accurately at weekly

intervals. Data integrity is almost 100 per cent, unlike in the earlier era. SLR (statutory

liquidity ratio) is more than adequate as a monetary tool, and also a resource platform for

government borrowings. So, why have an additional instrument in this age of data

awareness?

NO BASIS

For stability and soundness of the banking system, the RBI insists on capital adequacy ratio

in tune with latest Basel norms. To assess the strength of each bank in all parameters,

‘CAMELS’ (C – Capital adequacy, A – Asset quality, M – Management quality, E –

Earnings, L – Liquidity, S – Sensitivity to Market Risk) is monitored by the RBI through its

annual inspection mechanism.

Therefore, continuance of CRR, more so without any interest payout, has lost all purpose.

Much of a bank’s manpower and top management time is spent maintaining CRR on a daily

basis, and this is avoidable. Banks are customers to RBI, as far as maintenance of cash

balances with the central bank is concerned. Their demand from the RBI is akin to a bank

demanding cash margin from a borrower, and paying interest on the cash margin.

Therefore, the RBI cannot justifiably refuse to pay interest on CRR balances to its customer

banks when it is earning around Rs 12,000 crore surplus every year.

ENCOURAGE DEBATE

The SBI Chairman needs to be appreciated for raising the issue of CRR relevance in the

changed circumstances. Other bank chairmen, both in the public and private sector, should

rally behind him to persuade the RBI to revisit the issue.

The RBI should pay interest on CRR balances of its commercial bank clients. It also needs to

be open-minded to encourage free and frank discussion from the banking industry on many

regulatory issues, for the evolution of a healthy banking system.

CRR harsh on public sector banks :

Be the change you wish to see, said the Mahatma. But talking publicly about the change you want to see can be perilous to you if you are a banker — no matter how big a banker you are. The recent controversy caused by the statement on CRR by the Chairman of India’s biggest bank amply demonstrates this. SBI Chairman, Pratip Chaudhury wants to see a change — a change in the CRR, which according to him has outlived its purpose, and so has to be phased out.

The CRR is simply locked up in the vault, does not get ploughed back into the economy, does not give any interest to the banker, and increases the pressure on the banker to earn more from the remaining resources — these are the arguments he put forward. The response he got from the RBI was along expected lines, though not in the expected words.

Is CRR regulation such an infallible doctrine that it cannot be amended?

CRR is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults, or as deposits made with the central bank. In India, a certain percentage of the demand and time liabilities has to be kept as cash balance with the RBI, as per Section 42(2) of the RBI Act, 1934. This is in addition to the Statutory Liquidity Ratio (SLR), stipulated as per Section 24 of the Banking Regulation Act, 1949.

This reserve can be maintained as cash, gold or unencumbered approved securities. On the one hand, reserve requirements help the bankers to have enough cash to meet any eventuality.

On the other hand, they serve as tools in the hands of the regulator for controlling the liquidity in the system, thereby managing inflation. Alterations in the reserve requirements also influence interest rates by changing the funds available with the banks for lending.

ALTERNATIVES TO CRR

Cash reserves are no longer mandatory in many advanced countries. Australia, New Zealand, Canada, Sweden, have done away with it.

The UK has a system of voluntary CRR. In the US, CRR is calculated only on transaction accounts (checking accounts). The Euro Zone has a low CRR of 1 per cent.

At the other end, Pakistan, Bangladesh, Sri Lanka, Zambia and Mexico stipulate higher rates of CRR than ours. All BRIC countries still hold on to CRR and make periodical alterations to affect the liquidity. Except in countries with underdeveloped banking systems, the purpose of CRR is not safety, but liquidity. The emphasis has moved to capital adequacy ratios from CRR in many countries, as far as safety is concerned.

In India, banking is not what it was in 1934 or 1949. With the nationalisation of the major commercial banks in 1969 and 1980, the ownership and risk profile of banks in the country have undergone a sea change.

A major share of banking business in the country is handled by banks where the majority shareholder, if not the sole shareholder, is the government. Further, capital adequacy and income recognition norms are well established as per international standards.

The reference rates and open market operations are available with the regulator as tools to control money supply. Have we not reached a stage where we can review CRR?

BANKS IN A BIND

Banks in India, particularly the public sector banks, have an unenviable task to perform. NPAs have been mounting and the provision norms for restructured accounts will make matters worse. Stricter priority sector lending norms, such as that for direct agriculture lending, will further enhance the stress on margins.

On the one hand, the RBI Governor does not allow a reduction in reference rates for fear of inflation. On the other hand, the Finance Minister wants the interest rates to the borrower to be lowered. This can be done either by reducing the interest rates on deposits or by reducing banks’ profit margin. Even with the existing higher rates, deposit growth is slow in view of the low or negative real returns, and due to increased flow of funds to real-estate and gold.

Settling for a reduction in the profits will put further pressure on capital, particularly in view of the Basel III regulations to be implemented shortly. The government as the major shareholder will have to pump in more money. The concern expressed by the SBI Chairman at this stage is understandable.

DIFFERENTIAL CRR

Phasing out the CRR should be a distinct, even if distant goal. But what can be examined at this juncture is whether the CRR prescription is to be applied to all banks uniformly, irrespective of ownership.

The RBI can think of classifying banks into specific categories for CRR, say, banks with 100 per cent Government ownership, banks with more than 51 per cent government ownership, private sector banks and foreign banks — and stipulating different rates for different categories, with the necessary amendments to the RBI Act.

The CRR may be fixed at a lower level for the first two categories, in view of the higher safety level these banks offer to the depositors.

Higher levels of CRR can be fixed for the new entrants in the private sector, compared with the existing ones, for a specific period.

A differential rate of CRR will provide a better level playing ground for the public sector banks that are expected to play a more active role in social banking. It may be noted that the private sector banks are outperforming public sector banks in profitability.

Why not have variable CRR rates:

To start a public debate on cash reserve ratio (CRR) is welcome. But the RBI should take the debate to its logical conclusion by following its usual procedure of appointing an expert committee, inviting comments on the committee report from commercial banks, placing a discussion paper on this in its Web site, and then finally taking a call on CRR. In this context, the IBA (Indian Banks’ Association) can and should play a proactive role.

This article attempts to dwell upon some of the possibilities that might emerge for CRR.

Double benefit?

Can we innovate upon the existing system of maintaining CRR and make it a weapon not only for credit control and price stability but also for improving the safety and soundness of banks, particularly in the changed eco-financial situation?

The motivation for such a move comes from two strands of thought:

Price stability is the dharma of most central banks, particularly in EMEs (emerging market economies) like India because inflation hurts all and it hurts the poor and the middle class, who have fixed income, the most; and

The world’s political and economic leaders have realised that next to price stability, financial stability should be the goal of monetary policy of any central bank. And there is no equivocation about this, indeed. For instance, the very existence the EU and with it the ECB is today jeopardised because of financial instability in that region.

Different rates

Instead of having a uniform rate of CRR across the banking sector, we may have different rates of CRR for different banks, the rates being linked inversely to their risk levels measured in terms of their ‘published’ CRARs (as against the capital to risk (weighted) assets ratios computed independently by the central bank’s supervisory teams which are preferably kept confidential).

In other words, banks with higher levels of CRARs may be required to pay lower rates of CRRs and vice versa. The banks may be categorised into different class intervals of CRAR, say 5-10 per cent, 10-15 per cent, and so on, and the CRR rates may be calibrated to these class intervals and banks falling into these class intervals.

However, the base level CRR should continue to remain fixed at 3 per cent, as this is the price banks have to pay for operating under a fractional reserve system of banking our country is wedded to.

The variable rates of CRR will provide additional impetus to banks to maintain their asset quality and capital adequacy. Moreover, if CRR is abolished, the RBI’s quantitative tools of monetary policy will be effectively limited to the repo rate alone (since SLR is rather static), which is not an advisable situation. Any central bank must have an array of weapons in its armoury to fight against inflation and deflation.

To begin with, CRARs of banks reported in their ‘notes’ to annual balance-sheets may be taken for computation of their CRR rates. This may lend further stability to monetary policy of the central bank. Gradually, one may further fine-tune this by taking CRARs published by banks while announcing their quarterly results.

The next question is whether the central bank should pay any interest on the CRR money deposited with it by individual banks. It should, but only on the amount over and above the mandatory level of CRR computed at 3 per cent. The rate of interest payable to the banks by the central bank can be the same as the repo rate prevalent at different points of time.

The future of CRR looks quite exciting and no banker should shy away from contributing her/his intellect to this debate. This should be viewed as an opportunity rather than a problem by the bankers — both central and commercial.

Not just CRR, other monetary tools like government bond holdings & lending must also be debated

The RBI should refrain from using the CRR or SLR as a standard tool of monetary policy. At a more

basic level, every law is ennobled by a reason, and when the reason behind the law ceases, so does

the law itself. This is yet another reason to limit the use of changing SLR requirements as a tool of

monetary policy." It is not Pratip Chaudhuri, chairman of State Bank of India, who is saying it.

It is not even a banker who has his eyes on earnings so that its stock price rises. It was said by the then professor of economics in Chicago University's Booth School of Business Raghuram Rajan in a report of the Committee on Financial Sector Reforms in 2008 called A Hundred Small Steps. When Chaudhuri called for the phase out of the cash reserve requirement for banks on August 23, it was not for the first time that someone had raised the issue.

It was a debate that started nearly 20 years ago in India when the wheels of the economy began to rev-up , but has been lying dormant for some years now. It may be hard to believe that the CRR, the amount of deposits that banks have to keep with the Reserve Bank of India, and the SLR, the mandated government bond holdings, added up to 53.5% of total deposits in 1990.

Indeed, it began to fall once the reforms began to take shape, but like other reforms this also stalled. Though Chaudhuri reignited the debate on CRR, it is not just about the cash requirements issue. The debate should also include issues like SLR and directed lending to the priority sector. Failing to do so may be missing the woods for the trees.

Currently, more than a quarter of all deposits with banks are locked in either government bonds, or lying with the central bank with no interest. The argument is that these are essential to ensure that banks have a cushion against liquidity crunch when there's a run on deposits. Hardly anyone could argue against the principle. But the question is what should be the proportion .

Are these the reasons for private lenders paying high interest rates that fatten banks, which enjoy net interest margins of as high as 4%? "Why not completely abolish CRR?" asks Chaudhuri. "What is the purpose of CRR? To prevent banks from becoming insolvent? You have 23% SLR requirement, which you can't give as collateral to raise any loan. So how will a CRR of 4.75% help?"

Arithmetic shows that for the banking system as a whole Rs 17.4 lakh crore is locked up in these two provisions. Is so much required in a system where 75% of the banking industry is still owned by the state. If it argues it is like any other investor, the argument for state-ownership also evaporates. Lowering of these reserve requirements theoretically would release that much funds for private entrepreneurship, bringing down the cost of funds in general .

"I agree that CRR and SLR have to come down," says Deepak Parekh, chairman , HDFC, which controls HDFC Bank. "We have never thought of brining it down. We have to bring it down. Does any other country have this much? So I am in favour of brining it down and giving a nominal interest on CRR." But both these instruments in the hands of the central bank have transformed into an effective monetary tool when its policy rate adjustment does not get transmitted to market.This also provides stability.

"I think the monetary authority in its wisdom uses all these tools as appropriate and that's what is being done," says KV Kamath, chairman, ICICI Bank. This (CRR) is nothing new. India always had a CRR for as long as I can remember and I don't think honestly (there is) an issue to be made here... You should look at it as part of monetary policy that it is exercised and part of it is liquidity policy for the banks."

Although the financial system withstood the global storm in 2008 and many highlighted that Indian banks were not bailed out like the ones in the US, the position could not be seen reflecting the reality since many state-run banks were recapitalised many times in the past.

The RBI had set out to achieve 3% CRR as medium-term goal, but reversed midway to use it as a tool to fight liquidity and inflation.

It is also equipped with a legal provision not to pay interest rates, which many bankers call the biggest non-performing asset.

More than Rs 2.5 lakh crore is with RBI without interest, while banks pay an estimated Rs 20,000-crore interest.

When banks compete with mutual funds and deposit-taking finance companies, it may be time to consider Chaudhuri's arguments.

Few could deny that regulations and tax policies over the years have turned against banks, while favouring new avenues of financial intermediation, which individual investors are yet to embrace.

Also, the mandated investment for banks and insurance companies in government securities is resulting in financial repression. Government bonds ensure that there's credit safety, but there is no market safety.

One may get Rs 108 for every Rs 100 deposited, but does the purchasing power remain the same, or is it enhanced. In times of high inflation, such as in the past two years, the depositor actually loses purchasing power.

It is also debatable whether the government would be able to borrow at around 8% if only its regulators had not mandated such high SLR for banks and compelled that half the insurance premium be invested in G-secs .

"While the appropriate quantum and mode of maintaining such buffers will be debated in the years to come, the time has come to limit requirements of statutory holdings of highquality securities or cash reserves to only prudential purposes, and not for the purposes of funding government debt or for attempting to conduct monetary policy,'' said Rajan. Now that he is in the driver's seat, is there a hope?

Debate on CRR:

To be or not to be” may have rankled Prince Hamlet in Shakespeare’s play. In Mumbai, the debate over whether the cash reserve ratio (CRR) of the Reserve Bank of India (RBI) needs to be or not is engaging many of the banking biggies.

State Bank of India (SBI), CMD, Pratip Chaudhuri, who kicked off the debate by proposing to abolish CRR at a public event in Kolkata, has since made some foes and friends in the process.

He strongly advocated that the Rs 6,00,000 crore locked up with the central bank as a mandatory reserve under the CRR without the banks getting any interest on the cash pile

should be released for the good of the banking system. If not fully, at least a part of it.

CRR or cash reserve ratio is one of the two reserve ratios we have in India. It refers to a portion of deposits and also part of the advances that banks have to park with the central bank as a reserve to be made handy in the case of any eventuality in the financial system. It now stands at 4.75 per cent.

The other ratio is SLR or statutory liquidity ratio, which mandates banks to invest 23 per cent of deposits in government bonds — which of course gives banks an attractive interest rate.

Many would say it is wrong to ignite a debate on this, as Indian banks led by SBI are sitting on a rising stock of bad loans, which are expected to shoot up, as the economy slows down. China has a differential CRR, which goes up to 20 per cent, with smaller banks reserving smaller amounts.

Ashvin Parekh, national leader for global financial services at Ernst & Young, who has worked in financial markets across London, Germany and Australia, say reserve ratios are there in some form or the other in every country to insulate the economy from a systemic risk.

“Banks need to pay a premium for the stability provided by the regulator and the government. Every market across the globe used a set of instruments to prevent the systemic risks and in India, we have a system where 70 per cent of the banking system is dominated by government-owned banks,” he points out.

But what’s wrong with a debate? Pratip Chaudhuri told Financial Chronicle, “Rs 6 trillion is a national waste. If that money is available with the banks, it could be put to grow resourceful credit.”

With 70 per cent of the banking system owned by the government, it is but necessary that these reserve ratios stay. There have been times in India’s banking history when banks such as the Mumbai-headquartered Union Bank of India and the Kolkata-headquartered UCO Bank had to be recapitalised. Without these reserve ratios, the government may not have the wherewithal to fund such expensive bailouts.

Chaudhuri’s comment grabbed a few newspaper headlines and would have been forgotten. But that was not to be, as the vitriolic deputy governor of RBI, KC Chakrabarty, decided to shoot down the suggestion.

When Chakrabarty was pinned down for his reaction to the SBI chief’s proposal at a function in Kancheepuram, a small southern town in Tamil Nadu, he said, “If the SBI chairman is not able to do business as per our regulatory environment, he has to find some other place.” This created a furore.

Some officials in the banking circle say the SBI chief may be caught in his pursuit to please the government, often ignoring the sanctity of RBI.

“If the 2008-09 financial crisis did not affect India, it was in part due to the reserve ratios. We saw the UK pump in huge liquidity into financial institutions and the US government pumping in 90 per cent of the equity into AIG and banks in a huge $1 trillion programme,”

Parekh says.

The head of treasury of a private sector bank said, “All over the world, reserve ratios are a common practice to prevent systemic risk. SLR should be brought down to a more optimal level, but in times of stress, if we do not have reserve ratios, banks and financial institutions will go down under.”

Chaudhuri stuck to his guns and continued to support the idea “for the larger common good”. He also predicted that the central bank would cut CRR by 100 basis points in the mid-quarter review of monetary policy on September 17.

With reels of newsprint spent on the two gentlemen’s reactions, RBI governor D Subbarao, known for his sauve and gentle manners, decided to douse the debate by saying at a public function in Mumbai: “Late last night, I signed off a paper forming a committee. The terms of reference for the committee are whether we should continue with CRR or not,” he said at the annual Ficci-IBA banking conference earlier this week.

“The members of the committee are Dr Chakabarty and Shri Pratip Chaudhuri. The process of the committee will be that both of them will be locked up in a room until they reach a conclusion and the timeframe is that they will not submit their report till my term as governor is over.”

A few banking scribes rolled in laughter, but the more serious ones went back to the governor to ask him if he was joking.

Jokes apart, the debate just refused to die down. C Rangarajan, chairman of the economic advisory council to the PM, on Thursday supported the need to reduce the CRR. “The country needs to move towards a situation where the cash reserve ratio (CRR) level comes down and that it is used as an instrument of ‘credit control’ only in extraordinary conditions,” he said.

CRR was mainly used to neutralise the inflationary impact of deficit financing during the 1970s, 1980s and 1990s. Accordingly, it was gradually raised from its statutory minimum of three per cent in September 1962 to 15 per cent by July 1989 and again brought down to 4.75 per cent.

Now, will the central bank reduce CRR on September 17? Or will it actually set up a committee with a mandate to submit the report after the present governor steps down? The debate continues.....!

More:

Assocham wants interest free CRR to stay:

The Reserve Bank of India should continue with the interest free cash reserve ratio for effective monetary and liquidity management, Assocham said.

The industry body came to the above conclusion after ascertaining the views of stakeholders including industries, banks, and economists.

State Bank of India Chairman Pratip Chaudhuri’s views last week on cash reserve ratio led to a strong response from the RBI Deputy Governor K .C. Chakrabarty .

CRR is the portion of deposits that banks are obliged to set aside with the central bank. Currently, it is at 4.75 per cent of deposits i.e. for every Rs 100 deposit that a bank raises, it has to park Rs 4.75 in interest free deposit with RBI.

Banks, which collectively had deposits aggregating Rs 65 lakh crore as at July-end, do not earn interest on about Rs 3 lakh crore of funds locked up as CRR, said Assocham.

The industry body, in a statement, said a large section of stakeholders, including prominent bankers, want CRR to stay. It is one of the several key monetary tools by which the RBI drains excess liquidity from the system when it wants to follow a tight money policy to rein in high inflation and vice versa.

Those advocating CRR phase-out are of the view that it drains substantial funds out of the banking system, thereby imposing a cost on borrowers. Moreover, it is viewed as an idle asset.

Further, there are several other financial intermediaries like non-banking finance companies, insurance companies, and pension funds which are not subject to CRR and hence have an advantage.

However, Assocham observed that a strong and healthy monetary policy mechanism is a prerequisite to afford financial stability and quick response to any distortion.

“The case for continuation of CRR interest free is very valid as well as indispensable. It has worked well and perhaps is not an issue that needs any revisit,” it said.