Money & Banking

Why not have variable CRR rates

M. R. Das | Updated on August 29, 2012


The rate may be linked inversely to a bank’s risk level

To start a public debate on cash reserve ratio (CRR) is welcome. But the RBI should take the debate to its logical conclusion by following its usual procedure of appointing an expert committee, inviting comments on the committee report from commercial banks, placing a discussion paper on this in its Web site, and then finally taking a call on CRR. In this context, the IBA (Indian Banks’ Association) can and should play a proactive role.

This article attempts to dwell upon some of the possibilities that might emerge for CRR.

Double benefit?

Can we innovate upon the existing system of maintaining CRR and make it a weapon not only for credit control and price stability but also for improving the safety and soundness of banks, particularly in the changed eco-financial situation?

The motivation for such a move comes from two strands of thought:

Price stability is the dharma of most central banks, particularly in EMEs (emerging market economies) like India because inflation hurts all and it hurts the poor and the middle class, who have fixed income, the most; and

The world’s political and economic leaders have realised that next to price stability, financial stability should be the goal of monetary policy of any central bank. And there is no equivocation about this, indeed. For instance, the very existence the EU and with it the ECB is today jeopardised because of financial instability in that region.

Different rates

Instead of having a uniform rate of CRR across the banking sector, we may have different rates of CRR for different banks, the rates being linked inversely to their risk levels measured in terms of their ‘published’ CRARs (as against the capital to risk (weighted) assets ratios computed independently by the central bank’s supervisory teams which are preferably kept confidential).

In other words, banks with higher levels of CRARs may be required to pay lower rates of CRRs and vice versa. The banks may be categorised into different class intervals of CRAR, say 5-10 per cent, 10-15 per cent, and so on, and the CRR rates may be calibrated to these class intervals and banks falling into these class intervals.

However, the base level CRR should continue to remain fixed at 3 per cent, as this is the price banks have to pay for operating under a fractional reserve system of banking our country is wedded to.

The variable rates of CRR will provide additional impetus to banks to maintain their asset quality and capital adequacy. Moreover, if CRR is abolished, the RBI’s quantitative tools of monetary policy will be effectively limited to the repo rate alone (since SLR is rather static), which is not an advisable situation. Any central bank must have an array of weapons in its armoury to fight against inflation and deflation.

To begin with, CRARs of banks reported in their ‘notes’ to annual balance-sheets may be taken for computation of their CRR rates. This may lend further stability to monetary policy of the central bank. Gradually, one may further fine-tune this by taking CRARs published by banks while announcing their quarterly results.

The next question is whether the central bank should pay any interest on the CRR money deposited with it by individual banks. It should, but only on the amount over and above the mandatory level of CRR computed at 3 per cent. The rate of interest payable to the banks by the central bank can be the same as the repo rate prevalent at different points of time.

The future of CRR looks quite exciting and no banker should shy away from contributing her/his intellect to this debate. This should be viewed as an opportunity rather than a problem by the bankers — both central and commercial.

(The author is a former banker.)

Published on August 29, 2012

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