Monetary relics

RBI Governor Raghuram Rajan’s proposal to exempt long-term funds raised by banks to finance infrastructure projects from statutory liquidity/cash reserve ratio (SLR/CRR) requirements is well conceived. But one is tempted to go even further. Rigid SLR and CRR requirements are an anachronism in a liberalised economy — at the very least, they demand a fresh look. To force banks to invest 23 per cent of their deposits in government securities (G-Secs) — which is what the SLR is — is to pre-empt resources to fund government spending (read: profligacy) at the expense of private borrowings. In comparison, the CRR, which mandates banks to keep 4 per cent of their deposits with the RBI, is more of a monetary policy instrument. But this impounded money does not earn any interest and represents a loss of income that would have otherwise accrued from lending. Such a tool, too, needs to be re-examined in the light of a modern monetary framework in which there is less reliance on direct credit controls and where interest rates are predominantly market-determined.

Tinkering with SLR/CRR requirements is unlikely to cause any major shocks to the country’s financial system. Banks now actually hold some ₹3,30,000 crore of G-Secs in excess of their SLR requirements. This excess is a result of the lack of viable lending opportunities as well a desire to park funds in safe assets, which can also be used as collateral for borrowing in the repo market. The fact is that banks would continue to invest in G-Secs even if the SLR was abolished. But in the absence of a mandatory requirement, the Government would be hard put to run up huge fiscal deficits as there would no longer be any certainty that its bond issues will be comfortably subscribed. The same is true of CRR: dispensing with it is hardly going to undermine the RBI’s capacity to control money supply or influence interest rates. Why have a CRR when there are far superior monetary policy options before the RBI — from buying and selling bonds through open market operations to raising and lowering its repo rates?

For a start, the RBI could remove the SLR/CRR obligations on long-term bonds or deposits raised by banks to fund infrastructure projects. This is especially relevant in an economy in dire need of big-ticket investments. Given that infrastructure already accounts for over a third of all outstanding loans by banks to industry — not to mention a significant portion of their stressed assets — banks may well be reluctant to lend further to this sector. However, exemption from SLR/CRR requirements may persuade them to review lending to projects, for example, in the power, roads, and telecom sectors. But irrespective of whether this happens or not, it is time to take a long and hard look at pre-emptive financing and credit control tools that are not in sync with the post-reform era.

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