Tuesday, September 17, 2024

Has the cash reserve ratio outlived its utility, and could it be dispensed with over time? Economic Times 18th September 2024

 In India, cash reserve ratio (CRR) is at 4.5%, and banks keep aside around ₹10 lakh cr in cash. CRR doesn't earn any interest, and is an accepted cost while calculating marginal cost of funds-based lending rate (MCLR). Some believe that CRR may have outlived its utility and could be dispensed with over time. From a central banker's perspective, it needs to be there as it is an important tool for monetary policy.

Theoretically, CRR is a reserve maintained in the fractional reserve system, which serves as a basis for credit creation. Reserves are necessary in a liquidity crisis as banks can dip into this any time. From monetary policy perspective, it's a valuable tool for controlling the ability of banks to lend. An increase in CRR will reduce lendable resources, while a reduction will free resources. Even on the cost issue, banks should not be complaining about idle funds not earning revenue as the system.generates almost 10% of stable levels of free-floating demand deposits on which no interest is paid.

On the other side, arguments include CRR practically never being used, as RBI takes over immediately in a crisis. So, dipping into CRR is a possibility, though not a probability. Further, when the crisis is big, the amount may be too small to provide any support, as has been the case with some cooperative banks that went under.

RBI uses the liquidity framework that involves variable rate repo (VRR), and variable rate reverse repo (VRRR) auctions, to ensure that liquidity is balanced. This is a stated policy. Therefore, tinkering with CRR isn't required. Also, given that RBI has resorted to open market operations (OMO), where government securities are bought and sold more often than changed CRR, it stands to reason that the former is more effective when balancing liquidity.

Both are permanent measures, and have similar impacts. Finally, theory always says that price adjustments are more efficient than quantitative measures, and CRR falls in the latter category regarding regulation.

It is useful to see how the global systems look at CRR. The US dispensed with CRR after Covid.

In Japan, it's 0.8%, while Euro nations have pitched for 1%. In the developing world, Brazil has an astonishing 21% and Turkey 25% CRR. However, the latter has several economic challenges and is so at this level. China goes with 7%, Russia 8.5%, while the Philippines is higher at 9.5%, almost the same as Indonesia (9%). Malaysia is down the scale by 2%, as is Sri Lanka, which has faced several economic challenges.

 

By emerging markets standards, India's 4.5% CRR looks reasonable, even as it's on the higher side when compared with developed countries. Can there be a compromise solution? If there is a sense that a certain part of the bank's net demand and time liabilities must be kept aside for some prudential purpose, then a way out is to remove CRR but increase SLR.

This special increase can be called a 'precautionary SLR', which currently takes SLR up to 22.5%. For banks, this is better than a zero interest-bearing CRR. This precautionary SLR can be kept under held-to-maturity (HTM) bucket to provide comfort against mark-to-market (MTM) valuation changes. This way, the idle funds become revenue-accruing for the system.

The CRR lever can still be used by RBI to augment or lower liquidity in the system by changing the reserve requirement. And because they are government securities, it would be easy to sell them in the market during a crisis. Also, this will provide another source of demand for government securities in auctions.

 


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