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BW Businessworld

CRR Battle Far From Over

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CRR is in news again. This time, it is C. Rangarajan, chairman, Prime Minister's Economic Advisory Council, who says the Reserve Bank of India needs to bring down the cash reserve ratio (CRR) and control credit flow through open market operations.

"We need to move towards a situation in which the level of CRR comes down and it is used as an instrument of credit control only in extraordinary circumstances," he told reporters on the sidelines of a financial summit organised by industry lobby Ficci and IBA.

"As open market operation (an RBI tool to manage liquidity in the system) becomes increasingly a major instrument of credit control, the role of CRR as an instrument of credit control will come down," Rangarajan, himself a former RBI governor, said.
 
CRR is the proportion of deposits that banks need to keep with RBI as cash. Banks do not earn any interest on it.  At 4.75 per cent of deposits, CRR amounted to over Rs 3,20,000 crore on 16 August, upon which banks earn no interest.

In India, banks are struggling to maintain profitability and a non-productive CRR has begun to hurt. At the same time, RBI is fighting a  battle against inflation. In the current economic climate, the RBI needs as many tools as it can have to manage monetary policy, and the CRR is a key ingredient in its instrument mix. India is not an economy where capital mobility is so high that managing liquidity asymmetries can be handled without the CRR. It cannot depend on open market operations (OMO) alone as the Indian bond market lacks size and depth. For the banking system and the economy, CRR adds to the cost. Banks pay interest on deposits, but do not get anything on the portion parked under CRR, and the lending rate, therefore, is adjusted accordingly.

Earlier this month, the country's largest public sector lender State Bank of India had sought scrapping of CRR, which stands at 4.75 per cent. State Bank of India Chairman Pratip Chaudhuri, a proponent of "zero CRR" had got into a verbal scuffle with RBI deputy chairman K.C. Chakrabarty over whether CRR should be allowed to continue in India.
    
While RBI governor Duvvuri Subbarao made a joke about the whole episode at a banking event on 4 September, the fact remained that many a news-hungry reporter and market players were taken for a ride and believed him when he said that a committee is being set up look into the CRR issue. (Read: No Easing, Just Teasing, Says Subbarao)

According to SBI's Chaudhuri,"CRR does not help anybody,... it is locked up in the vault and not ploughed back into the economy … it needs to be phased out as it does not earn any interest income and increases pressure to earn more from remaining resources". The RBI was quick to retort. Deputy Governor K. C. Chakrabarty had bluntly remarked that Chaudhuri "has to find some other place" if he could not work within RBI regulations.

Not all central banks follow the same practice. In the United States, the reserve requirement is in respect of transaction (current) accounts and is at about 10 per cent. There is no reserve requirement for time deposits. In the UK, it is voluntary. On average it is about 3 per cent. In the euro zone, the reserve requirements are at 1 per cent.

Pitch For CRR Cut
On 5 September, Chaudhuri again made a strong pitch for a reduction in CRR at the Reserve Bank’s mid-quarter review of monetary policy scheduled September 17.

“I would like to be optimistic. I expect a one per cent cut in CRR,” he said, when asked about his expectation, at the sidelines of the Ficci-IBA banking seminar. “It is likely that a cut in CRR will bring changes in the base rate (BR).” The BR is the benchmark lending rate to which all loan rates are linked.

Chaudhuri said a one per cent cut in CRR would release Rs 10,000 crore for SBI. This could be deployed and earn the bank at least Rs 800 crore. The benefit could be passed on to borrowers by lowering the BR.

According to Chaudhuri, the correlation between the repo rate and the BR was weak. “If you look at SBI, a one per cent CRR cut releases Rs 10,000 crore, on which if you put a value of eight per cent is Rs 800 crore. So, that is the amount that can be passed on to borrowers. If you have a repo rate cut, the total increment benefit is not even Rs 100 crore. "

Among other things, Chaudhuri has also asked for interest payment on the CRR, emboldened by the finance ministry's suggestion on the same issue.

Chakrabarty on his part, in an interaction with The Hindu said on 3 September: “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.”

While there have been some support for Chaudhuri on his expecation on CRR cut and charging of interest on it, he has faced mostly opposition on his 'zero CRR' theory. Industry body Assocham on 4 September strongly advocated for continuation of CRR for effective liquidity management in the banking system.

"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," Assocham said in a release.

ICICI Bank Chairman K V Kamath has 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.

Whether CRR completely disappears from the Indian banking scene or not, the thought process has started to reduce it's importance for controlling liquidity. As BW pointed out (A Question Of Timing ), the idea of a statutory debate for lower CRR must be debated, and it looks like its time has come.

(With input from agencies)