SHOULD CRR BE DONE AWAY WITH?

Subject : Banking & Insurance

Cash Reserve Ratio

The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the Reserve Bank of India (RBI) as a certain percentage of their Net Demand and Time Liabilities (NDTL) .

For example if the CRR is 10% then a bank with NDTL of Rs 1,00,000 will have to deposit Rs 10,000 with the RBI as liquid cash.
This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio.

Cash Reserve Ratio

Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks dont hold these as cash with themselves, but deposit such case with Reserve Bank of India (RBI).

Cash Reserve Ratio

Thus, When a banks deposits increase by Rs 100, and if the cash reserve ratio is 5%, the banks will have to hold additional Rs 5 with RBI and Bank will be able to use only Rs 95 for investments and lending / credit purpose.

Therefore, higher the CRR, the lower is the amount that banks will be able to use for lending and investment & vice-versa.

Cash Reserve Ratio

When the CRR is increased, the amount of funds that a bank can lend decreases. Banks then try to encourage more deposits by increasing the interest rates. Rising interest rate usually discourage loan seekers as a higher interest rate means that the cost of money has increased.

RBI (Amendment) Bill, 2006

The Reserve Bank of India (Amendment) Bill, 2006 has been enacted. Consequent upon amendment to subSection 42(1), The Reserve Bank, having regard to the needs of securing the monetary stability in the country, can prescribe CRR for scheduled banks without any floor rate or ceiling rate.

Before the enactment of this amendment, the Reserve Bank could prescribe CRR for scheduled banks between 3 per cent and 20 per cent of total of their demand and time liabilities

No Interest Payment

In view of the amendment carried out to RBI

Act 1934, omitting sub-section (1B) of Section 42,

The Reserve Bank does not pay any interest

on the CRR balances maintained by SCBs

RBI stopped paying interest to banks on their

CRR deposits in 2007.

Objectives of CRR
Ensures Safety and Liquidity of Deposits.
Preventing banks from going into insolvency.

Tool for Controlling Liquidity

o To drain excess liquidity o To release funds needed for the economy

CRR Rates (1935-2012)

16 14 12 10 8 6 4 2 0

CRR

Maintenance of CRR

For the purpose of maintaining CRR, every

scheduled bank is required to maintain a Principal Account with the Deposit Accounts Department (DAD) of the Reserve Bank at the centre where the principal office of the bank is located.

Reporting Requirements

All SCBs are required to submit to Reserve

Bank a provisional Return in Form 'A' within 7 days from the expiry of the relevant fortnight

The final Form 'A' return is required to be

submitted to RBI within 20 days from expiry of the relevant fortnight.

Calculation of CRR

The prescribed CRR during a fortnight has to

be maintained by every bank based on its NDTL as on the last Friday of the second preceding fortnight.
order to improve cash management by banks, as a measure of simplification, a lag of one fortnight in the maintenance of stipulated CRR by banks has been introduced

In

Maintenance of CRR on Daily Basis

With a view to providing flexibility to banks

in choosing an optimum strategy of holding reserves depending upon their intra fortnight cash flows,

All SCBs are required to maintain minimum

CRR balances up to 70 per cent of the average daily required reserves

Credit Expansion

Should CRR be abolished?

Should CRR be abolished?

Pratip Chaudhuri (SBI - Chairman) argued that CRR should be completely abolished

SBI Chairman & CRR

"Why is CRR not applied to insurance and other companies who are mobilizing deposits from the public? The pinch of high lending rates which the customers are facing is the result of CRR. 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. CRR acts as a tax on the banking system.

SBI Chairman & CRR

CRR was meant for preventing banks from going into insolvency. o Since banks already have to deposit 23 per cent of their money in government bonds as Statutory Liquidity Ratio (SLR), there is no point of having CRR. CRR is an NPA (non-performing asset) for banks.

SBI Chairman & CRR

CRR costs banks a loss of approximately Rs. 21,000 crore, out of which Rs. 3,500 crore to SBI alone, due to lack of interest received per year (No interest payment)
Total Deposits in all Scheduled Commercial banks 65 lakh crores

CRR: 4.75% of above to be kept with RBI

Expected Interest earned on CRR deposits made with RBI

65 lakh crores x 4.75%=around 3 Lakh crores

3 lakh crores x 0% = Rs.0

Estimated Interest loss for an year at 7% p.a

Rs 21,000 Crores P.A.

EAC - Chairman & CRR

C Rangarajan Chairman - Prime Minister's Economic Advisory Council (EAC)

EAC - Chairman & CRR

"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,"

"As OMO (open market operations) becomes

increasingly a major instrument of credit control, the role of CRR as an instrument of credit control will come down,".

Deputy Governor - RBI & CRR

KC Chakrabarty (RBI - Deputy Governor)

Deputy Governor - RBI & CRR

RBI was quick to react when Deputy Governor KC Chakrabarty bluntly said, "If the SBI Chairman is not able to do the business in this regulatory environment, he has to find some other places.

Governor - RBI & CRR

D. Subbarao (RBI - Governor) central bank has set up a committee to review the need to retain the much-debated CRR (Pratip Chaudhuri & K.C. Chakrabarty)

Why Abolish CRR

Why only Banks No Interest payment Acts as a tax burden NPA for Banks Loss of apprx. Rs. 21000 SLR (insolvency) OMO (Credit Control)

CRR should not be Abolished

US came up with the concept of cash reserve as early as 1863. cannot ignore or doubt the credibility of CRR one of the major tool for RBI gives banks liquidity cushion. protects the interest of depositors frequent cases of bankruptcy of private banks & co-operative banks in India

CRR should not be Abolished

CRR is very effective because it directly takes out or induces liquidity into the system OMO may be good for supplying liquidity, but may be ineffective for drawing it out as banks can choose not to buy paper from RBI which is offered to them. However, CRR is compulsory to all Banks.

In fact, CRR is even more powerful than the repo rate