Cash Reserve Ratio (CRR) Controversy between SBI & RBI: meaning, implication on Economy Explained
- What is CRR?
- What is Scheduled Commercial Bank?
- Examples of Scheduled Commercial Banks 1. Case # 1: High CRR and SLR 2. Case # 2: Low CRR and SLR
- Repo Rate
- Reverse Repo Rate
- Bank Rate
- What is the need for all these CRR, SLR, Repo rates?
- What is the problem with CRR?
- How much CRR deposit does RBI have?
- What does SBI want?
- Deputy Governor of RBI
- Timeline of Events
- Mock Questions Before proceeding further, do read the earlier articles on 1. Statutory Liquidity Ratio (SLR) 2. Cost-Push Inflation 3. Demand-Pull Inflation What is CRR? CRR means Cash Reserve Ratio. Banks in India are required to hold a certain proportion of their total deposits with RBI in cash form. Right now, CRR is about 4. 75% that means if people deposit total Rs. 100 in SBI, then SBI would have to deposit Rs. 4. 75 in RBI. This is CRR or Cash Reserve Ratio. CRR rule doesn't apply to Regional Rural Banks, Non-Banking Financial Companies (NBFC), Mutual funds, or insurance companies.
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What is Scheduled Commercial Bank? Scheduled banks are those banks which have been included in the second schedule of the Reserve bank of India act of 1934. The banks included in this schedule list should fulfill two conditions. The paid capital and collected funds of the bank should not be less than Rs. lakhs. Any activity of the bank will not adversely affect the interests of depositors
Public Sector Majority of stake is held by the government.
- State Bank of India (SBI)
- Punjab National bank (PNB) Private Sector Majority stakes are held by private players. 1. ICICI, 2. HDFC, 3. AXIS Bank
- Case #1: High CRR and SLR Suppose total deposit deposited in (by you and me) State Bank of India =Rs. 100 Total Deposit CRR: 15%SBI has to park this much amount of total deposit in RBI, without getting any interest. SLR: 38%SBI has to park this much amount of total deposit, in Government securities/treasury bonds. SBI earns around 7. % interest rate on this investment. click me for more on SLR Money left with SBI Rs. 100 -15 -38 100-1538=Rs. 47
- Case #2: Low CRR and SLR Total Deposit CRR: 4. 75%SBI has to park this much amount of total deposit in RBI, without getting any interest. Rs. 100 -4. 75 SLR: 23%SBI has to park this much amount of total deposit, in Government securities/treasury bonds. SBI earns around 7. 5% interest rate on this investment. Money left with SBI -23 100-4. 7523=Rs. 72. 25 In either case, as long as you’re running a bank, you’ll have some input costs such as 1.
Salary to Bank PO, Clerks, peons and security guards (With rusted guns)
- Office rent
- ATM machine’s electricity and maintenance.
- Newspaper advertisements. To pay above salary and bills, SBI would need to maintain a certain amount of profit margin, no matter what RBI does with CRR, SLR, or Repo Rate. In Case# 1, when SBI has only Rs. 47 in the hands, what can it do to keep the profit margin the same? Obviously SBI will have to increase the interest rates on car, home, bike, business loans given to customers.
In case# 2, when SBI has Rs. 72, what can it do? Here the situation is not that bad. So, SBI chief would decrease the interest rates on car, home, bike, business loans to seduce more customers. We already discussed this- SBI has more money so it can cut down interest rates and suffer a temporary reduction in profit, in order to seduce more customers (compared to ICICI) So once SBI has reduced the interest rates, other banks will need to reduce their interest rates, to stay in the competition. Let’s continue assuming the Case# 2, that SBI has only Rs. 72. 25 left in its locker. SBI chief comes to know that recently Samsung Company has launched Galaxy S3 mobile so plenty of youngsters may want to buy it because of the advertisements that appear on TV channels 24/7 Thus there will be demand for more personal loans (EMI) or credit card based shopping. But SBI got only Rs. 72. 25. So SBI chief would borrow some more money from RBI interest rate and then re-lend this money to customers as personal loan 16% (and thus making a killing profit of 16-8=8%) or he can supply money to customers for Credit Card shopping, and in that case, he can earn interest rate anything between 16-37% or even more (depending on hidden terms and conditions of a credit card. )
RBI will pay the SBI chief a 7% interest rate on such a deposit. Thus, Reverse repo rate is the interest rate in which RBI pays its client s* for their short-term deposits. Note: Reverse Repo Rate is automatically kept 1% less than the Repo rate according to new RBI rules. Side Question Why would SBI chief put his money in RBI? Because on your normal savings account in SBI, the chief pays you around 4% interest rate, while RBI is giving him a 7% Reverse repo rate, so he’s making a profit of 3%. Bank Rate Bank rate is the interest rate that RBI charges from its clients* for their LONG-term loans. Recall that Repo Rate = RBI charge that much interest from its clients on SHORT term loans.
Who’re the clients of RBI?
- Union Government
- State Government
- NABARD (through that money goes to Microfinance companies and Regional Rural Banks)
- Commercial Banks (SBI, ICICI, etc)
- Non-Banking Financial Companies (NBFC) like Muthoot Finance and Mannapuram Gold Loans. (the list is not exhaustive.)
Bank Rate, Repo Rate, and Reverse Repo Rate apply to all Clients of RBI. The CRR, SLR applies to Commercial Banks. (including Urban Cooperative banks but excluding Regional Rural Banks).What is the need of all these CRR,SLR,Repo rates?
RBI’s main job = control inflation by controlling the money supply in the market.
Too much money in the market =easy to get loans= not good.
Because It’ll create inflation. [Demand Pull] Too less money in the market= again not good, because businessmen find it hard to get loans, thus input cost of production increases= not good for the economy either and it’ll create inflation. Cost push]
Therefore, RBI will increase/decrease these CRR, SLR, and Repo Rates according to the situation in order to adjust the money supply in the market and thus control inflation. [Monetary policy] Nowadays RBI doesn’t touch Bank rate much and mostly relies on the Repo rate to control the money supply. CRR and SLR are also not changed as frequently as the Repo rate. And Reverse repo rate is automatically kept 1% less than Repo rate, so that makes Repo rate the “most frequently used tool” in RBI’s monetary policy, in the last two years.
Apart from that, CRR, SLR, and Repo Rate also help those competitive magazine wallas to fill up pages with ridiculously unimportant data tables to make your life more miserable. What is the problem with CRR? How much CRR deposit does RBI have? In July 2012 [all approximate numbers]. Total Deposits in all Scheduled Commerical banks (SBI, ICICI, etc) CRR:
4. 75%Banks have to keep this much amount of total deposits in RBI. Interest earned by SBI/ICICI etc on CRR deposits made in RBI 65 lakh crores x 4. 75%=around 3 Lakh crores sitting idle in RBI lockers.
lakh crores x 0% = Rs. 0 If SBI/ICICI etc. could lend these 3 lakh crores (CRR deposits) to customers 10%, they could easily earn Rs. 30,000 crores in interest payment. Thus, CRR makes a huge difference in the profit of banks. UK, Canada, Sweden, Australia, and New Zealand don't have a CRR system in any form. In the USA, there is a graded system i. e. small banks don’t need to maintain any CRR with their central bank. While “big” banks would need to maintain CRR Deposit according to their size. Side Question: How “big“? Answer: no need to do Ph. D on that question trail.
By the way, USA’s RBI (Central Bank) is known as the Federal Reserve system and commonly known as “Feds”. So sometimes while randomly surfing through BBC/CNN you might come across lines like “Market boomed /crashed after Feds cut down the rates” they’re talking about USA’s RBI changing their repo, SLR, etc. rates Interestingly, USA’s RBI (Feds) pays interest on the CRR deposits, while India’s RBI doesn’t pay any interest on CRR deposits. What does SBI want? Recently SBI Chairman Pratip Chaudhari said that CRR does not help anyone and it is unfair to apply it only on banks. Even if CRR is required why should it be on banks alone? There are a number of institutions that raise funds from the public – insurance companies, mutual funds, and NBFCs so CRR should be applicable to all. Because of CRR, every year we lose Rs. 3,500 crore. Pratip Chaudhari = Chairman of SBI In India, Businessmen get a loan 11 percent while that for a Chinese equipment manufacturer gets a loan in his country for only 4 percent. So CRR= less money in market= higher interest rate= increases the input cost of Indian products. Deputy Governor of RBI
Which of the following st at ement s are incorrect?
- The NBFCs are required to maintain CRR deposits with RBI.
- RBI pays interest rates on CRR deposits.
- An Increase in CRR would decrease the liquidity from the market.
- At present, Bank Rate > Repo Rate > Reverse Repo Rate.
Q2. Which of the following st at ement s is correct?
- Repo rate is the interest rate paid by RBI to banks on short term deposits.
- A decrease in repo rate will increase the home loan interest rates.
- HDFC is a Non-scheduled Commercial bank.
- SLR is always 20% higher than CRR.
Q3.What were the steps taken by RBI in its monetary policy during 2011 to control inflation in India? Do you think RBI achieved its objective? Give reasons to justify your stand. (Mains)
Q4. If you were the RBI Governor, what steps would take regarding the CRR issue? (interview)
- Indian Economy by Ramesh Singh (Tata McGraw hill Publication)
- http://moneylife. in/article/cash-reserve-ratio-a-non-performing-asset-forbanks/28066.html
- http://www.allbankingsolutions.com/DATA.htm August 30th, 2012, Category: Economy.
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