Money & Banking

Repo rate cut is ‘direct way to reduce cost of funds for banks’

| Updated on: Jun 05, 2015
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Cutting CRR is a back door policy: Rajan

Though some bankers have been demanding a cut in Cash Reserve Ratio (CRR) on and off, the Reserve Bank of India is of the view that a repo rate cut is a direct way to reduce cost of funds for banks.

“Yes, this is a question that some bankers raise occasionally, cut CRR. I think it should be recognised that CRR is primarily a monetary instrument.

“If we want to reduce the cost of capital and reduce lending rates, the more direct instrument to use is the policy rate which we have used,” RBI Governor Raghuram Rajan said in his post-policy conference call with researchers and analysts.

In its second bi-monthly monetary policy, announced on June 2, the RBI cut the policy repo rate (the interest rate at which banks borrow short-term funds from the central bank) from 7.50 per cent to 7.25 per cent even as it kept the CRR unchanged at 4 per cent of banks’ deposits.

CRR is the slice of deposits that banks have to park with the RBI.

“Now, CRR for the bankers clearly represents uncompensated reserves that they hold with the central bank. It is absolutely necessary to keep it uncompensated because that is the way we essentially drive the monetary policy transmission through the credit multiplier…,” explained Rajan.

What credit multiplier means is that an increase in the amount of money in the economy has a multiplier effect on the amount of credit created by banks.

“…So this notion that somehow cutting CRR will reduce the bank’s cost of funding. Yes, it will. But, it is effectively a back door policy. The direct way of cutting the bank’s cost of funding is to reduce the policy rate,” Rajan said.

Small reduction

Also, if one estimates the effects (of a CRR cut), they are actually quite small, he added.

The Governor observed that a one percentage point reduction in the CRR, that is a 25 per cent reduction in where the CRR is right now, will reduce the banks’ cost of funding by about 7 to 8 basis points. However, the RBI has done a 25 basis points cut in the policy rate. One basis point is equal to one-hundredth of a percentage point.

“Over time that (cut in policy report rate) should reduce the banks’ cost of funding by 25 basis points, as their deposits and liabilities adjust. Which is more? 25 basis points policy rate (cut) or the 25 basis points cut in CRR that they are talking about?

“Clearly, it is the 25 basis points cut in the policy rate. So I do not understand this discussion of CRR that sometimes comes up,” said Rajan.

Michael D Patra, Executive Director, said the RBI expects a full transmission (of the repo rate cut to bank lending rates) as has happened in the wholesale funding markets.

“Remember that after 50 basis points that were (repo rate) cut until now, already half has been passed through (by way of lending rate cuts)… 25 to 30 basis points have been passed through and we expect them to pass the rest fully,” he said.

Published on January 24, 2018

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