RBI hasn't hit banks PDF Print E-mail
Wednesday, 30 November 2016 00:28
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Shobhana's edit

What they lose on CRR will be made up on reverse repo

While banks are upset about RBI imposing a 100% CRR on incremental deposits of Rs 3.2 lakh crore, sequestering the excess liquidity was necessary given the sharp fall in bond yields. The yield on the benchmark bond dropped to 6.23% last Friday, below the repo rate, resulting in an inverted yield curve. The contracting spread between the domestic and US yields – which have been rising ever since Donald Trump became President-elect of the US – prompted foreign investors to sell bonds worth $3 billion between November 8 and November 28 and that, in turn, is what has added to the pressure on the rupee; as lakhs of crore rupees more flow into banks, not mopping this up would only make things worse.

In the ideal situation, analysts have argued, RBI should have mopped up the liquidity via Market Stabilisation Scheme (MSS) bonds or reverse repos but these are less flexible/temporary as compared with the CRR. Also, the central bank was running out of securities and enhancing the MSS quota would take some time. By choosing to impound, for now, Rs 3.2 lakh crore through CRR, RBI has bought itself time till Parliament okays more MSS and, more important, it has saved on the need to issue an equivalent amount of securities to mop up this amount. While banks are upset because they will have to pay 4% on Rs 3.2 lakh crore of deposits while earning nothing on the CRR – that’s a loss of Rs 1,000 crore if the RBI imposes the CRR for a month – if over Rs 8 lakh crore of extra deposits have come in already, they will earn arbitrage on the balance through the reverse repo. Since at least another Rs 4-5 lakh crore more will come in, the banks’ earnings from the arbitrage will further increase. The ‘loss’ on account of the CRR also has to be juxtaposed with the benefits to banks as, with large tax inflows due to the demonetization, the government’s ability to recapitalize banks will also increase.

In the absence of the incremental CRR, while banks could perhaps have parked the deposits in gilts, lending it was never an option because, as SBI Chairman Arundhati Bhattacharya pointed out, the deposits were unlikely to be ‘sticky’ – a fair assessment since people are likely to withdraw the cash as fast as banks can disburse it. Since some part of the deposits will be sticky, though, banks will have more deposits as the rest of the demonetized money flows back into the system. But since the central bank will have to go back to its neutral stance on liquidity and suck out these deposits, this means it will have to go in for a repo cut if it wants banks to lower lending rates. Given inflation is expected to remain benign and that growth is expected to suffer due to the demonetisation, the central bank may well consider some monetary easing on December 9.


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