The Reserve Bank of India (RBI) announced on August 10 that it will be imposing an incremental cash reserve ratio (ICRR) of 10 per cent on the increase in banks’ net demand and time liabilities (NDTL) between May 19 and July 28. This measure is intended to absorb the surplus liquidity in the banking system, which has been building up in the recent months due to several factors, including the return of ₹2,000 notes to the banking system.

The ICRR will be effective from the fortnight beginning August 12. It will apply to all scheduled banks, including commercial banks, cooperative banks, and regional rural banks.

ICRR is RBI’s new tool to manage liquidity in the banking system. It is a percentage of the incremental increase in a bank’s net demand and time liabilities (NDTL) that the bank is required to maintain as cash reserves with the RBI.

The RBI had been using other tools such as variable rate, repo rate and the reverse repo rate, to manage liquidity, but these tools were not having the desired effect. The ICRR is a more targeted tool that is specifically designed to absorb excess liquidity. It is a temporary measure which will be reviewed in three months.

ICCR impact

First, it will reduce the amount of money that banks have to lend, which could lead to higher interest rates. It could probably make it more difficult for banks to raise capital, and it could impact their profitability.

However, the ICRR is also expected to help to stabilise the rupee, which has been under pressure in recent months. It could also help to reduce inflation, which has been rising recently.

The ICRR could lead to higher interest rates as banks will have less money to lend, which will drive up the demand for loans. Higher interest rates could make it more expensive for businesses to borrow money, which could slow down growth.

However, higher interest rates could also help to reduce inflation. ICRR could also strengthen the rupee making imports cheaper, which help to reduce inflation. However, a stronger rupee also make exports more expensive, hitting export sectors and growth.

Stock market impact

The ICRR is also likely to impact the stock market. A higher CRR lead to lower stock prices, as investors become more cautious about the economic outlook. However, if the ICRR helps to reduce inflation and stabilise the rupee, stock prices will look up in the long run. Overall, the impact of the incremental CRR on economic indicators and exchange rates is uncertain as of now. It depends on various factors, including the extent to which the ICRR reduces liquidity in the banking system, the reaction of businesses and consumers to higher interest rates, and the global economic environment.

However, the RBI is likely to continue to monitor the situation closely and take additional measures if necessary to combat inflation.

It will be interesting to see how the ICRR is used in the coming months and it is too early to assess its long-term impact. The RBI may decide to extend the measure if it believes that it is necessary to continue to absorb surplus liquidity in the banking system. These measures are expected to help to reduce inflation in the coming months.

Saravanan is a professor of finance and accounting at IIM Tiruchirappalli and Williams is an analyst at Sernova Financial

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