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28
November 2016
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RBI (The Total Investment & Insurance
Solutions)
In a surprise move last week, the Reserve
Bank of India (RBI) raised cash reserve ratio (CRR) of banks to 100% of net
demand and time liabilities (NDTL). The central bank's intent is to absorb a
significant portion of the liquidity surge created in the banking system since
8 November 2016, after the government moved to demonetise bank notes of Rs500
and Rs1,000 denomination. However, this move would negatively impact banks, say
research reports.
In a report, Care Ratings says, post the CRR
hike, banks will have to park an additional sum of Rs3.24 lakh crore with the
RBI without earning any interest. "This amount, which is incremental
deposits between 16th September and 11 November 2016, would be still paying a
minimum of 4% interest to deposit holders. In addition, there is a fear of a
penalty being imposed in case banks are not able to deposit the same with the
RBI," the ratings agency says.
In a report, State Bank of India (SBI) says,
to be fair to the central bank, CRR has ceased to be an instrument of monetary
control in India since the mid 1990’s, with the CRR being brought down sharply
since then. "Interestingly, during the early 1990’s additional CRR
requirements (in the form of incremental CRR) were introduced from time to
time. For example, an incremental CRR of 10% was also levied on various
non-resident deposits in order to restrict inflows during such time. Against
this background, the imposition of a 100% incremental CRR seems unprecedented
and is the first time in history. In fact, the Chakravarty Committee in 1985
had suggested that the incremental CRR should be used only in special
circumstances requiring drastic monetary control measures. By this analogy,
this imposition is therefore a drastic control measure," it says. The Total Investment & Insurance
Solutions
The higher CRR is applicable on incremental
deposits raised between 16th September and 11 November 2016. That would mean
deposits of over Rs3.24 lakh crore that accrued to banks during this period
will be impounded by the RBI. The central bank calls this a 'purely temporary
measure', which will be reviewed on or before 9 December 2016. The Total Investment & Insurance
Solutions
Ratings agency CRISIL feels that the RBI is
trying to neutralise two consequences of demonetisation using a blunt tool.
"One, by raising the CRR to 100% of NDTL, it will drain excess liquidity
temporarily and, two, such a giant mop-up will support the 10-year G-sec yield,
which fell below the repo rate on Friday. Given that liquidity has surged by an
order of magnitude after demonetisation, mopping it up required more than just
vanilla reverse repo auctions. Between 8th and 25 November 2016, funds parked
by banks with the RBI under these auctions surged 10 times to Rs1.5 lakh
crore," it says.
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CRR (The Total Investment & Insurance
Solutions)
According to Care Ratings, this move by RBI
was necessitated by the fact that the central bank at present holds Rs7.56 lakh
crore of rupee securities (G-Secs and T-Bills) and will soon run out of options
of going in for reverse repo auctions, where it sells G-Secs in return for cash
from banks, which have surplus deposits. These transactions have been reckoned
at rates between 6.21%-6.25%. "There are expectations that the volume of
deposits will increase by up to Rs10 lakh crore by December because of the
demonetisation scheme. The present equation of Rs3.24 lakh crore impounded by
CRR and Rs7.56 lakh crore to be used as open market option (OMO) or reverse
repo auctions broadly covers this amount, leaving no extra margin," it
added. The Total Investment &
Insurance Solutions
There were alternative measures available
with the RBI, which should have been used, feels SBI. It says, "...they
were available like cash management bills issued by Government and securities
issued under MSS scheme. We understand such measures require the concurrence of
the Government, which should not have been a problem. In particular, cash
management bills may have meant better liquidity management since their short tenor
would have meant banks having headroom to deal with eventual outflows when the
withdrawal limits are unwound."
The Total Investment & Insurance Solutions
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Liquidity (The Total Investment & Insurance
Solutions)
(Source: CRISIL)
There could be two implications (of the RBI
move), Care Ratings says, adding, "As the level of deposits keep
increasing, banks may have to park the increments as CRR with RBI which will
affect their profit and loss (P&L). The expectation so far has been that
the RBI will lower the repo rate aggressively in the December policy by 50
basis points (bps). This may be deferred till stability is achieved in the
system. Depending on further RBI action or announcements in the period running
up to the policy, our expectation on rates would be moulded." The Total Investment & Insurance Solutions
According to CRISIL, the immediate impact of
this step will cause liquidity to tighten and send bond yields on a northward
blip. "However, more liquidity is expected to make way into the banking
system in the coming days in the aftermath of demonetisation, which will ease
the pressure on yields."
"The other impact is on interest rate
transmission. Banks could delay cutting their lending rates given that they
have promised at least 3-4% interest rate to savings account depositors, but
will be not be receiving any interest on the deposits impounded for CRR,"
the ratings agency says.
SBI says under the current circumstances,
when the banking system has been flooded with liquidity, it believes that the
RBI may have limited options. "However, we would like to emphasize further
reactive policy decisions (say of changes in market stabilisation scheme (MSS)
structure or deposit addition beyond 11 November 2016 subject to same
treatment) will create unnecessary and unwanted market hype and build up adverse
market expectations about impending policy announcements. Therefore, forward
guidance in terms of what constitutes 'reactive policy' based on market
developments; and decisions based on the medium term outlook needs to be
clearly demarcated and differentiated accordingly while communicating with the
market. This must be a part of monetary policy announcement in December,"
it concluded.The Total Investment &
Insurance Solutions
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