Indian banks may see their net interest margins (NIMs) improve by at least two basis points with the RBI cutting the cash reserve ratio (CRR) by 25 basis points. CRR, the amount of deposits bank have to set aside with the RBI, does not earn any interest for the banks. Therefore, a cut in CRR would help improve the margins and, as a consequence, their profitability. The Bank Nifty gained close to 3.2 per cent on Monday.

A 25 basis points cut in the reserve ratio will infuse Rs 17,000 crore into the banking system.

The cut will be more beneficial for banks with higher cost of funds — mainly old private sector banks. Smaller banks will benefit too, as these banks tend to deploy their monies in lending rather than SLR securities.

The cut will aid banks’ margins in two ways.

First, the money which didn’t earn any interest can now be deployed into interest-earning assets. This would add close to two basis points to the NIMs of banks, assuming banks just park their money in government securities. The margins will be higher if they lend rather than invest in government securities.

And, second, given that they now have additional liquidity, to that extent, banks need not borrow money from the repo window or call market. Hence, banks which borrow heavily from the repo window will be saving on interest expenses as well. The benefit for such banks will be higher net interest margin. Some banks can take this as an opportunity to even cut lending rates to improve credit offtake.

The liquidity situation in the current quarter is well within RBI’s comfort levels with banks on an average borrowing Rs 42,600 crore through the repo window. With one-year incremental credit-deposit ratio falling from 93 per cent in March 2012 to 83 per cent as of August 2012, many banks have cut deposit rates citing lower demand for credit.

However, RBI expects the credit offtake to pick up in the second-half. Additionally, deposit rate cuts, advance tax payout and higher currency holding may further reduce liquidity. While RBI on its part can continue open market operations, it has instead chosen to release primary liquidity in the form of CRR. The reason being the money multiplier is higher in the case of CRR cut.

The RBI already holds a significant chunk of government securities — 17.6 per cent of the outstanding as of June 2012 as against 12.9 per cent in June 2011.

> santosh.majeti@thehindu.co.in

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