Blogs

Posted by: Deepa Vasudevan on Fri, May 29th, 2015

Why bankers prefer a CRR cut to a repo rate cut

As we approach the Second Bi-Monthly Monetary Statement due on June 2, 2015, there is much discussion about the likely stance of monetary policy. The corporate sector, as always, wants RBI to cut the policy repo rate. On the other hand, banks are hoping for a reduction in the Cash Reserve Ratio (CRR). Both policy measures have the common goal of reducing interest rates. Then why are bankers rooting for a cut in CRR rather than the repo rate?

 

To understand, let us begin by explaining the base rate, which is the minimum rate at which banks can lend. The base rate is bank-specific, and is usually computed on the basis of the weighted average cost of funds.  Since about 90% of bank funds consist of deposits from the public, it is obvious that the base rate is impacted mainly by the cost of deposits.

 

The policy repo rate is the rate at which banks can borrow from the RBI LAF window against the collateral of government securities.  Banks do not access repo funds unless there is a liquidity deficit. Repos do not fund routine banking operations. The policy repo rate and the base rate are linked through the monetary transmission process. When RBI cuts the repo rate, it expects the rate reduction to be transmitted across the economy: starting from short term money market rates, and moving on to the base rate.

 

CRR is the portion of bank deposits that have to be maintained with the RBI as cash. Banks do not earn any interest on CRR balances, effectively, it is idle cash. When CRR is reduced, banks have more funds available to loan out.

 

From the point of view of a bank, CRR represents money impounded by the RBI that could have been otherwise productively deployed. A cut in CRR improves interest margins immediately, because the additional funds can be put to work to earn something! A cut in repo rate will improve interest margins only if it results in lower deposit rates, and that will happen only with a lag, because it takes time for new, lower cost deposits to form a sizable part of the fund pool. That explains why banks are keener on a CRR cut rather than a repo rate cut.

 

A 50 bps cut in CRR will release over Rs.40,000 crore into the banking system; which is roughly about 10% of the incremental growth in bank credit in 2014-15. That’s not a small amount in an economy where credit growth is at historically low levels. 

 

The Central bank will need to weigh the obvious liquidity-enhancing benefits of reducing CRR against banks’ reluctance to increase lending. Banks are sitting on excessive cash for reasons ranging from poor credit demand, rising bad loans to inability to reduce cost of funds.  Getting banks to lend and industry to borrow will require a restoration of the investment-credit cycle. A mere CRR cut may not be enough.

Siddhi S Ambre on Fri, Aug 7th, 2015 4:11:45 pm

Excellent, highly informative

DILIP ROPLEKAR on Sat, May 30th, 2015 3:04:52 pm

(1) It is true that when CRR is cut Banks will have surplus funds to lend,but Banks are all ready flushed with liquidity and unable to lend in the market due to lack of receipt of good quality proposals on one side & if loans are disbursed there is fear of A/C(s) turning NPAS on the other side. which will compel Banks to make higher provisions resulting into adversely affecting Banks profitability. (2) If CRR is cut their will be large amount of liquidity flushed in the market which will lead to high inflation in the market. (3) There is long pending demand from Bankers that RBI to give interest on CRR funds parked with RBI which will enhance the profitability of Banking system. (3) It is experience of Banks that during Q-2 period there is no demand of funds from the market & any measures taken to flush the liquidity in Banking system will not serve meaningful purpose. (4) Banks need to get effective tools to deal with large amount of NPA(S) without any polotically interference. (5) RBI needs to evolve a system & effective direction(s) to Banking industry that any changes made in the policy rates Banks need to proportionately pass on in the banking system without RBI appealing Banks to do the needful which will automatically balance market without waiting for the corporate sector to pass on to the consumer which is heather to not done by them.

chandrshekhar kulkarni on Sat, May 30th, 2015 10:28:33 am

i think mere cut in CRR doesn't make sense, when there is nobody to off take loan from bank.i.e. no loan demand instead RBI should go for reducation in repo rate , cut interest rate by 0.5 point basis. so bank will pass on client so credit demand will rise in coming 3 to 4 months which will spurt economic activities

Post a Comment

Subscribe to Newsletter

Stay updated with what's new. We'll keep you posted on the latest featured topics

Blogroll

No Blogroll.