CRR:is it necessary?

The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum fraction of customer deposits and notes that each commercial bank must hold (rather than lend out) as reserves. These required reserves are normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank. Cash reserve ratio is the amount of funds that all scheduled banks have to keep with RBI without any floor or ceiling rate with reference to the net demand and time liabilities to ensure the liquidity and solvency of the banks sec 42(I) of the banking regulation act 1934).The current CRR rate now is currently at 4% which dropped down from 4.25% at a reduction of 25 basis points. The repo rate has also been adjusted to 7.75% and reverse repo rate has been adjusted to 6.75%.Similarly the bank rate has also been adjusted to 8.75% The required reserve ratio is sometimes used as a tool in monetary policy, influencing the country's borrowing and interest rates by changing the amount of funds available for banks to make loans with.[1] Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling government-issued bonds) to implement their monetary policy. The People's Bank of China uses changes in reserve requirements as an inflation-fighting tool, and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits.

CRRS HISTORY It may be recalled that the CRR was mainly used to neutralise the inflationary impact of deficit financing of the government during the 1970s, 1980s and 1990s.

Accordingly, it was gradually raised from its statutory minimum of 3 per cent in September 1962 to 15 per cent by July 1989. Furthermore, under the monetary targeting framework, M3 (Broad Money) was the intermediate target (nominal anchor for policy) of monetary management, with reserve money as the operating target and the CRR as the key operating instrument. With the introduction of multiple indicator approach, the use of CRR as an instrument of monetary control was sought to be de-emphasised and liquidity management in the system was increasingly undertaken through indirect instruments such as open market operations (OMO), both outright and repos. CONCEPT OF CRR The CRR is a direct monetary instrument used by the RBI for monetary policy intervention. The Reserve Bank of India Act, 1934, was amended in June 2006 with a view to enhancing the RBIs operational flexibility and providing it with greater manoeuvrability in monetary management. The Reserve Bank of India (Amendment) Act, 2006, gives discretion to the RBI to decide the percentage of scheduled banks demand and time liabilities to be maintained as CRR without any ceiling or floor. Consequent to the amendment, the Reserve Bank was also not required to make interest payment on CRR balances. Consequent to the amendment in June 2006, the RBI announced the removal of the floor of 3 per cent and ceiling of 20 per cent in respect of CRR. Thus, in an operational sense, there is no prescribed limit of CRR as in the past. It is the RBI which decides on the magnitude of CRR as per its liquidity comfort zone. It is also a means to control creation of bank money by the banking system. The payment of interest on CRR balances attenuates the effectiveness of the CRR as an instrument of monetary policy. From the fortnight beginning June 24, 2006, it was decided that no interest shall be payable on CRR balances. It is pertinent to note that the decision had the concurrence of the Government of India. Thus, currently, the RBI maintains CRR at 4.75 per cent of the net demand and time liabilities (NDTL) of the SCBs and no interest is paid.

Why was CRR Introduced?

The Reserve Bank of India (Amendment) Bill, 2006 has been enacted and has come into force with its gazette notification. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate. [Before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, 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].

RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.(a) ensures that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money.

CRR in Different Countries United States In the United States, a reserve requirement (or liquidity ratio) is a minimum value, set by the Board of Governors of the Federal Reserve System, of the ratio of required reserves to some category of deposits held at depository institutions (e.g., commercial bank including US branch of a foreign bank, savings and loan association, savings bank, credit union). The only deposit categories currently subject to reserve requirements are net transactions accounts, mainly checking accounts. The total amount of all net transaction accounts held in USA depository institutions, plus US currency held by the nonbank public, is called M1. A depository institution can satisfy its reserve requirements by holding either vault cash or reserve deposits. An institution that is a member of the Federal Reserve System must hold its reserve deposits at a Federal Reserve

Bank. Non-member institutions can elect to hold their reserve deposits at a member institution on a pass-through basis. A depository institution's reserve requirements vary by the dollar amount of net transaction accounts held at that institution. Effective December 29, 2011, institutions with net transactions accounts: Of less than $12.4 million have no minimum reserve requirement; Between $12.4 million and $79.5 million must have a liquidity ratio of 3%; [4] Exceeding $79.5 million must have a liquidity ratio of 10%. The numerical amounts stated above are recalculated annually according to a statutory formula. Effective December 27, 1990, a liquidity ratio of zero has applied to CDs, savings deposits, and time deposits, owned by entities other than households, and the Eurocurrency liabilities of depository institutions. Deposits owned by foreign corporations or governments are currently not subject to reserve requirements. When an institution fails to satisfy its reserve requirements, it can make up its deficiency with reserves borrowed either from a Federal Reserve Bank, or from an institution holding reserves in excess of reserve requirements. Such loans are typically due in 24 hours or less. An institution's overnight reserves, averaged over some maintenance period, must equal or exceed its average required reserves, calculated over the same maintenance period. If this calculation is satisfied, there is no requirement that reserves be held at any point in time. Hence reserve requirements play only a limited role in money creation in the USA. United Kingdom The Bank of England holds to a voluntary reserve ratio system, with no minimum reserve requirement set. In theory this means that banks could retain zero reserves, effectively allowing an infinite amount of credit money creation. However, the average cash reserve ratio across the entire United Kingdom banking system is higher, with a 3.1% average as of 1998.

Other countries in Asia China Chinas current CRR is 21.7%.However,rate cuts took place in December 2012 due to the euro crisis and the CRR was dropped by 50 basis points. A government clampdown on property speculation has added to the risk of a deeper slowdown in the economy that contributes most to the global economic growth. The economy grew 9.1% in the third quarter from a year earlier. Its weakest pace since the second quarter of 2009. Exports rose by the least in almost two years in October and inflation eased to 5.5% in the smallest gain in five months. Pakistan The State Bank of Pakistan current cash reserve ratio is 8 percent, effective from Oct. 11. The central bank will further slash the CRR to 7 per cent effect from Nov. 15. The State Bank of Pakistan said a cumulative decrease of 200 basis points (bps), from 9 per cent to 7 per cent, would release 61 billion rupees ($767 million) into the system. The cental bank believes these measures were to counteract the effects of high inflation and the government borrowing as it is very high. ARGUMENTS AGAINST CRR

The following arguments are generally put forward against maintenance of CRR. First, CRR is an inflexible instrument of monetary policy that drains liquidity across the board for all banks without distinguishing between banks having idle cash balances and those that are deficient. Second, in case CRR is not remunerated, it has the distortionary impact of a tax on the banking system. Third, CRR is also discriminatory in that it has an in-built bias in favour of financial intermediaries that are not required to maintain balances with the Reserve Bank. In the above context, it is important to note that in order to keep liquidity in the Liquidity Adjustment Facility (LAF) window at the optimal level of plus/minus one per cent of NDTL for effective monetary transmission, the RBI needs to have instruments at its disposal to manage excessive liquidity deficit/surplus conditions. The role of the LAF window is to deal with frictional liquidity deficit/surplus. Liquidity of a more durable nature needs to be managed with other instruments such as CRR and Market Stabilisation Scheme to deal with the surplus liquidity situation arising out of large capital inflows. This has been highlighted many a time by the RBI. To quote from a speech of former RBI Governor Y.V. Reddy (September 7, 2007): While the preferred instruments are indirect, and varied, there is no hesitation in taking recourse to direct instruments also, if circumstances so warrant. In fact, complex situations do warrant dynamics of different combination of direct and indirect instruments, in multiple forms, to suit the conditions affecting transmission mechanism. In view of the foregoing, it can be said that the CRR currently as a monetary policy instrument should not be viewed as a tax on the banking system. To do so, especially in view of the fact that the current CRR rate is just 4.75 per cent, is to gloss over the complexities of liquidity management, as has been rightly pointed out by Reddy. Therefore, the suggestion that CRR be modified or phased out seems unreasonable.

The arguments against CRR were convincingly set aside in an article by S.S. Tarapore, published in these columns (Interest on CRR, a big mistake Business Line, August 24). The present status of CRR, sans interest on balances, is designed to provide greater flexibility to the RBI as the monetary authority to conduct monetary management. To reiterate, suggestions in favour of abolition of CRR and interest payments on CRR are unwarranted, and best avoided in the interest of monetary policy independence.

How CRR and Repo Rates Help Impact Liquidity The Reserve Bank of India has various tools to control and maintain liquidity in the market. Two among them are the CRR and Repo rate. Repo Rate: The repo or repurchase rate is the interest charged by the RBI to banks when they approach it for short term loans. The repo rate is linked to the interest rate borrowers pay when they take loans from banks because the latter always charges interest which is higher than the existing repo rate. Hence, lower repo rates could induce lenders into lowering the interest rates they charge from individual borrowers too, thereby making credit more affordable. CRR determines bank interest rates: If a man had deposited Rs.1,000 in his account when the CRR was 5%, the bank will have at its disposal Rs.950 after it deposits Rs.50 as CRR. The bank in turn lends the Rs.950 to a borrower who will eventually repay the bank.

The bank will once again lend this amount (Rs.950) to another borrower after depositing 5% of the amount (Rs.47.5) to the RBI. In this manner, the money will keep exchanging hands, or it continues to be created and available for subsequent borrowers. This means that Rs.1,000 is helping generate a far higher amount in the economy in an indirect manner. Therefore, even if the CRR were to be increased by only 1%, the money generated in the economy would reduce drastically. Repo rate and inflation: When the repo rate is raised, banks are compelled to pay higher interest to the RBI which in turn prompts them to raise the interest rates on loans they offer to customers. The customers then are dissuaded in taking credit from banks, leading to a shortage of money in the economy and less liquidity. So, while on the one hand, inflation is under controlled as there is less money to spend, growth suffers as companies avoid taking loans at high rates, leading to a shortfall in production and expansion. The RBI revises CRR and repo rates in their quarterly and mid-quarter policy reviews to maintain a balance between growth and inflation. The past two years have been proof of this practice as the apex bank tried to first tame the monster of inflation with aggressive rate hikes, and once it saw growth taking a hit, reduced key rates to revive the economy.

This si the general CRR trend line that has been continuing in our economy. How CRR cut impact the growth of a economy-Montek singhs view(planning commission ) CRR is an important tool for the RBI to maintain inflation and liquidity in the economy. Higher CRR has always been a tool for the RBI to curb inflation and

suck out the high liquidity that is present in the economy.Montek singh of planning commission believes that government should focus on the rate cuts for the growth of the country rather than focussing on inflation. He is of the view that CRR cut would have stronger impact on interest rate than simply adjusting the repo rate because bank does not lend freely at the repo rate and it does not play the role which FED fund rate do in the U.S. On the fiscal consolidation road map chalked out by Union Finance Minister P. Chidambaram, he said, We are determined to bring the fiscal deficit down. On whether monetary policy is in sync with fiscal policy, he said, ...enough has been done to indicate a start in other policies like fiscal consolidation, reforms and moving big projects... the direction that monetary should move is quite clearly to be supportive of that. About the lowering of growth projection for this fiscal to 5.8 per cent this fiscal from earlier estimates of 6.5 per cent, he said, If we do 5.8 per cent GDP growth this fiscal that would actually imply very significant improvement over the results that we have got for the first quarter. I think that the growth in the second quarter would be similar to first quarter. If we do 5.5 in the first six months, can we do better in next half. I think we can. Therefore 5.8 per cent is not broadly off the mark, he added.

CRR rate cuts a welcome for the Indian economy-P.chindamabaram Finance Minister P Chidambaram has welcomed RBIs decision to cut interest rates and said more steps will have to be taken by the Government to boost growth. They (RBI) have taken the call now, they have given the reasons...and I welcome the decision. But interest rates (are) ... one issue that India faces. There are many other issues that have to be addressed and I hope we can address them in the days ahead, he told the Financial Times in an interview. He was commenting on the decision of the RBI to reduce interest rate by 0.25 per cent and release Rs 18,000 crore of additional liquidity in the system by lowering cash reserve ratio (CRR) by a similar margin. Noting that there is always a debate between need to promote growth and contain inflation, Chidambaram said so one has to do a tradeoff between

inflation and growth, and I have argued my colleagues in Government have argued that perhaps a monetary authority should lean a little more in favour of growth. However, it is up to the central bank to take a call on the extent of monetary easing, he said. When they should do that, to what degree they should do that is their call. They have taken the call now, they have given the reasons, Chidambaram said. The other key issues, which are needed to be addressed by the government to promote growth, include environmental clearance, forest clearance, other approvals, bank finance for projects. Impact of CRR rate cut on the Banking community Bankers view on rate cutBankers were not happy with the RBI policy. They expected a cut in repo rate which didnt come. The 25 bps cut in CRR will not significantly impact lending rates, they feel. Further, they seemed unpleasantly surprised with the RBI move to impose an additional provisioning of 0.75 per cent on standard restructured assets. K. R. Kamath, Chairman of Indian Banks Association, and CMD, Punjab National Bank: The 25 basis point CRR cut will give room for more credit to the productive sector and, to some extent, impact the cost of banks. An unpleasant surprise was in the form of the additional provisioning for the restructured assets. The 0.75 percentage point hike, when translated, will hit profitability by as much as 3 per cent. While we are not in the position to earn 3 per cent of the profit through the 25 bps CRR cut, to that extent we (banks) will be in deficit. Chanda Kochhar, MD and CEO, ICICI Bank: Over a period there will be some softening in interest rates, but with the CRR cut we do not see any immediate rate cut. Interest rate reduction moves only with a reduction in cost of funds. The175 bps CRR cut over the year has helped banks reduce cost of funds and cut rates. However, each step may not be substantial enough to warrant an immediate change.

The market would look forward to a policy rate reduction by the RBI in the coming months. Pratip Chaudhuri, Chairman, State Bank of India: Being an optimist, I had expected a 50 bps cut. A 25 bps CRR cut will give an additional liquidity of about Rs 2,750 crore to SBI. On our restructured book, which is at Rs 35,000 crore, a 0.75 per cent increase would require an additional Rs 300 crore which is not very significant as we had budgeted for about Rs 10,000 crore provisions. On the rate cut, our ALCO (asset liability committee) will meet in a day or two and we will assess our optimal net interest income. Aditya Puri, Managing Director, HDFC Bank: We are examining the pros and cons and over time the rates are likely to come down in this fiscal year. S. L. Bansal, CMD, Oriental Bank of Commerce: The benefits arising from CRR cut will be offset by the additional provisioning requirements on restructured loans. The 25 bps CRR cut will release Rs 400 crore for OBC and translate to earnings of about Rs 32 crore on an annual basis. But the additional provision requirement on restructured loans will compel the bank to provide Rs 82-83 crore, which will wipe out the gains from CRR cut. Net-net, there is no gain for us from the policy announcements. M. Narendra, CMD, Indian Overseas Bank: The policy addresses persisting inflationary threats. By cutting CRR by 25 basis points, the RBI has made available Rs 17,500 crore for meeting the commercial needs during the ensuing busy season.However, banks are unlikely to tweak interest rates in the immediate future considering the mounting pressure on profitability from rising NPAs. The review has underscored the threat from NPAs and hiked the provision for restructured standard accounts which will further squeeze profitability. The RBI is examining the feasibility of introduction of long-term fixed interest rate retail loan products which will be welcomed by retail borrowers. T. M. Bhasin, CMD, Indian Bank: Banks will hardly get much relief on the liquidity front as whatever fund is released by way of a CRR cut will be offset by the requirement for higher provisioning for restructured standard accounts. So it looks unlikely for banks to pass on the benefit to their customers. Though a uniform rate cut across the board might not be possible immediately, however, softening of rates might happen in certain sectors.

P. Jayarama Bhat, MD, Karnataka Bank: The CRR cut by 25 basis points was on expected lines. This cautious stand was warranted in view of the higher inflation projection in the near term and the prevailing fiscal condition. The impact of the increased provision for restructured standard accounts will vary between banks. Those with a large share of restructured assets may see their profitability being affected more. S. Chandrasekharan, Executive Director, UCO Bank: It might take one--two months for banks to pass on the benefit by way of a reduction in lending rates. We have already garnered some deposits at higher rates which have to be shed at first. Once we are able to garner deposits at lower rates we will be able to pass on the benefit to customers. Highlights of the current CRR rate cuts on the economy

The current document gives us a glimpse of what changes and impacts we are having on the economy.

CRR:is it good or bad? Positives of CRR Rate cut: Indian economy breathes easier after rate cut Rupee rises past 53 to over three-and-a-half month high Increase in liquidity in the economic system. The reduction in the rates will come as a relief for the banks as a high CRR ratio locks up funds for which they earn nothing. Now banks will have more to lend. The

additional liquidity will make credit less scarce and less dear, benefiting businessmen and individuals. The CRR rate cut will fuel all-round growth and also have a positive impact on business sentiment to create new investment opportunities. Overall,CRR is beneficial for our Indian economy.

BIBLOGRAPHY AND REFRENCES http://www.indiantaxupdates.com/2013/01/29/rbi-cuts-repo-rate-crr-by-25-bps-each/

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