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Banks: Solving the CRR puzzle - Views on News from Equitymaster
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Banks: Solving the CRR puzzle
Jun 27, 2006

Cash Reserve Ratio (CRR) is the minimum cash balance required to be kept by banks with the RBI. By serving as an instrument of monetary policy, the CRR helps the central bank regulate the flow of liquidity in the banking system. Banks, hitherto, also earned interest on the funds parked in the form of CRR (above the statutory minimum) with the RBI. The recent amendment to section 42(1) of the RBI Act, however, spells concerns for the banking sector. The current mandate…
Before the enactment of this amendment, the RBI could prescribe CRR for banks between 3% and 20% of their net demand and time liabilities (NDTL). Hitherto, banks have been required to maintain minimum CRR balance of 3% of NDTL on a daily basis, subject to the average maintenance of 5% of NDTL during the fortnight. Also, the RBI has been paying interest on CRR balances above the statutory minimum of 3% and up to the prescribed level of 5% (known as eligible cash balances) - at an interest rate determined by the central bank (3.5% since September 2004). It must, however, be noted that no interest is payable on any amount actually maintained in excess of the prescribed level of 5%.

With the amendment to the RBI Act…
While the RBI has maintained a status quo with regard to the level of CRR, the amendment to the RBI Act, to be effected from June 24, 2006, exempts the RBI from payment of any interest on the balance in excess of 3% of NDTL. Also, the amendment has scrapped the floor and cap limits (earlier 3% and 20% respectively) for RBI’s regulation of the CRR.

At a time when the banking sector is under a severe liquidity strain, parking idle funds with the RBI without any remuneration on the same would certainly prove costly to the players in the sector. Nevertheless, given the negligible contribution of the interest earned on CRR to their net interest income, we do not see the same significantly impacting the banks’ NIMs.

Extent to which banks will feel the heat…
FY06 (Rs m) Cash with RBI % of NDTL Interest earned % of NII
SBI 195,720 5.1% 2,660 1.7%
OBC 42,632 8.5% 351 2.2%
ICICI Bank 90,796 5.5% 1,156 2.8%
HDFC Bank 33,066 5.9% 391 1.5%
UTI Bank 24,294 6.1% 281 2.6%

What could change?
If the move is construed as a step towards narrowing the CRR limit to the statutory minimum level of 3% (as per RBI’s target), the same could prove to be very benign for the sector. Besides freeing up additional liquidity for the sector, the excess funds (2% of NDTL), thus deployed in advances /investments would yield a meaningful contribution to the net interest income.

Scope for earning…
FY06 Deployable funds# Avg. yield* Interest earned % of NII
SBI 76,753 7.9% 6,063 3.9%
OBC 10,031 7.7% 772 4.8%
ICICI Bank 33,017 7.1% 2,344 5.6%
HDFC Bank 11,209 7.5% 841 3.3%
UTI Bank 7,965 7.4% 589 5.5%
# 2% of NDTL (CRR in excess of 3% upto 5%)
*Average yield on advances and investments

Our view
The scrapping of the floor and cap limits of the CRR lends the RBI additional flexibility in terms of controlling the monetary aggregates. Also, with no incentive to park funds idly with the RBI, banks will be more proactive in routing them to more fruitful purposes. While temporarily, the amendment might appear to be a negative for the banking sector, we see the same proving to be benevolent once the CRR limits are lowered to the statuary minimum level. The upcoming first quarter review of the monetary policy is, thus, expected to take a stand on liquidity besides interest rates.

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