Will Reserve bank go for a CRR cut?

Context: Although there sems to be broad consensus that the repo rate is likely
to remain unchanged at 6.5% in the three-day monetary policy review that got
underway on Wednesday, there is an expectation that the Reserve bank of India
(RBI) may announce a cut in the cash reserve ratio (CRR). The reduction may occur
due to the gained momentum amid a tight liquidity condition in the banking
system and shockingly low Gross Domestic Product (GDP) growth, which slowed to
a seven-month low of 5.4% in the July-September 2024 quarter.

Key points

·       Overview:
The Reserve Bank of India (RBI) began its three-day monetary policy
review. There is increasing speculation that the RBI may announce a cut in the
Cash Reserve Ratio (CRR) to ease liquidity pressures.

·       Cash
Reserve Ratio (CRR): CRR is the percentage of a bank’s total deposits
that it must maintain as liquid cash with the Reserve Bank of India (RBI) as a
reserve. It is a tool used by the RBI to manage inflation and check excessive
lending by banks. As of now, the CRR is set at 4.5% of a bank’s Net Demand and
Time Liabilities (NDTL). Banks do not earn interest on the amount they maintain
as CRR with the RBI.

·       CRR
Requirements for Different Types of Banks: Scheduled Commercial
Banks (SCBs) - Includes Public Sector Banks (PSBs), Private Sector Banks
(PVBs), Regional Rural Banks (RRBs), Small Finance Banks (SFBs), Payments
Banks, Primary (Urban) Co-operative Banks (UCBs), State Co-operative Banks
(StCBs), and District Central Co-operative Banks (DCCBs).

Non-Scheduled
Co-operative Banks & Local Area Banks - They must maintain CRR with
themselves or with the RBI.

·       Restrictions
on CRR Funds: Banks cannot lend the funds held as CRR to corporates
or individual borrowers. The money held under CRR cannot be used for investment
purposes by the bank. No Interest is earned on the funds maintained as CRR by
banks with the RBI.

·       Incremental
CRR (I-CRR): Introduced temporarily on August 10, 2023, to absorb surplus liquidity
in the banking system. Banks were required to maintain 10% I-CRR on the
increase in their NDTL between May 19, 2023, and July 28, 2023. The I-CRR was
implemented from August 12, 2023, and applied during periods of excess
liquidity in the financial system.

·       Impacts
of Declining CRR on the Economy: Positive Impacts - Increased
Bank Liquidity: A reduction in CRR frees up more funds for banks, improving
credit availability and promoting investment and consumption. Stimulus for Economic
Growth: With more funds to lend, businesses can secure loans more easily,
boosting economic activity and encouraging growth across sectors. Lower
Interest Rates: As banks have more liquidity, they may lower interest rates on
loans, making credit cheaper and encouraging investment and consumer spending.

Negative Impacts
-
Potential Inflationary Risks: Increased lending and spending can raise demand,
which, if not matched by supply, can lead to inflationary pressures in the
economy. Asset Bubbles: Excess liquidity may result in overvalued assets like
stocks or real estate, creating the risk of unsustainable price increases and
potential market instability.