By: Joydeep Dass
Faculty – Finance
Introduction – A cash reserve ratio (CRR) is a compulsory cash reserve every bank is required to maintain with the Reserve bank of India (RBI). CRR is an effective tool of monetary control to squeeze out excess cash from the economy if the RBI feels that liquidity needs to be restricted or contained for economic fluctuations. Section 42 of the RBI Act authorizes the central bank to notify the quantum of cash reserve ratio to be maintained by the scheduled banks by way of a deposit with the RBI. The current CRR rate is 4% & SLR rate is 19.5%. Some of the arguments in support are outlined below.
First, CRR causes a huge strain on the financial resources of a bank. There is a huge opportunity cost as the money set aside for deposits with the RBI could have been ploughed effectively for lending to various sectors in the economy thereby creating growth. Moreover, The RBI does not pay any interest on the cash reserve it holds and it is a major lost opportunity for the Banks. Cash deficient banks suffers the most and are almost on the verge of running out of business. The recent example of consolidation of Dena, Vijaya & Bank of Baroda is a case in point where Dena bank had to be pulled out for cash & capital deficiency. Cash reserve with RBI is in itself a Non Performing Asset (NPA) for the banks.
Second, RBI has mandated adoption of BASEL III standards, which stipulates mandatory liquidity ratio of 100% effective January 2019. With Basel III implementation, a CRR is not actually required in India, as it will cause additional strain on the Banking system. If a bank has to comply with both the RBI and the BASEL norms, it will fork out additional 10-12% of its precious cash deposits. Though BASEL norms are a recommendation and not mandatory but RBI wants BASEL III compliance for all banks in India. RBI needs to loosen the regulatory strings and CRR abolition could be a first step towards that direction.
Third, Statutory Liquidity Ratio (SLR) is already in place and an instrument for the RBI to contain speculative spending by banks, indiscriminate lending and excess cash. CRR in addition to SLR is like taxing the bank for public deposits it has secured by sound banking practices. Additionally the CRR as a policy tool to control inflation in the economy has not also yielded the desired results. Price rise has always been an economic issue and will continue to be a cause of concern. Cash supply in the economy is not the sole cause of price rise but supply side factors are a major contributing factor. RBI’s contention of controlling inflation without considering mismatch in supply and demand is untenable. Prior to demonetization in 2016, there were huge amounts of unaccounted money in circulation in the economy and even today parallel economy still exists. The Government & RBI claims that all old currencies have come into the system, which is farcical. If CRR were a measure to contain money circulation than it has failed to achieve its economic objective.
Fourth, If the Government cannot do away with CRR than at least it should introduce CRR norms for other sectors in the economy like Insurance, NBFC’s, Debt Funds who mobilize huge amounts from the public in the form of premiums. Taking away cash from the banking system is not the only solution for monetary control of the RBI. Penalizing banks for monetary control is simply unjustified as the Banking is the most tightly regulated sector in the economy. Squeezing cash out of the banking system also causes contagion effect on other formal economies and hurts economic growth. RBI say that CRR is similar to production cost of running a business and the business can adjust the pricing to recover this cost and this opinion is without any justification. Banks are burdened with huge costs of running the business leaving very little for credit lending.
Fifthly, central banks of major advanced economies have either abolished CRR requirements’ or moving towards zero reserve requirements. These countries have been able to maintain inflation within reasonable limits without a CRR limit. India can take examples of matured economies from Sweden, Canada & UK and consider abolishing CRR in a phased manner or at least pay some interest like the SLR (Statutory Liquidity Ratio). Banks suffer at the cost of public deposits because banks have to pay interest on these deposits to its customers regardless of whether the deposits are generating any income for the bank. Banks will lose vital banking business to NBFC’s (Non-banking financial Institutions) & AIF (Alternate Investment Funds) who is now aggressive in the Indian financial sector.
Lastly, India has the highest spread between lending rates and the deposit rates, which causes the cost of financial intermediation to be high putting strain on banks’ capital. Additionally a number of banks are facing the problem of asset liability mismatch because they have a tendency to lend long and borrow short. CRR regulation adds further to the ALM (Asset-Liability Management) mismanagement. CRR abolition, will improve Government Finance because it can save money, which is otherwise required for recapitalization of the capital deficient banks. The opportunity cost of diverted funds is huge as Government can unlock value by productive utilization of bank capital funds in other priority areas where it is required instead of infusing endless capital in loss making banks.
Conclusion – There seems to be divergent opinions on the subject of CRR abolition and it appears that CRR will not be abolished anytime sooner in India. RBI may consider reduction in CRR rates but not in support of abolishing CRR. RBI says CRR is a regulatory mechanism where all banks should adhere to and cannot be withdrawn. In reality, CRR is a medium to fill up the coffers of the RBI with an excuse of exercising regulatory supremacy. The debate should continue around it and its relevance in the current scenario should be widely discussed. CRR abolition would release huge amounts of funds, which is being held by the RBI. CRR abolition will also lead to reduced competitive lending rates, which will ultimately benefit the economy in the long run as currently the hidden costs of CRR is recouped by increasing the lending rates. The CRR norms may be diluted and the RBI in consultation with the Industry need to relook at CRR as a fiscal policy instrument for the overall benefit of the Industry and the economy.
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