CRR and Repo rate

A PTI report  says,

"Dismissing IBA’s demand for a CRR cut to better help banks reduce lending rates, RBI Governor Raghuram Rajan on Tuesday said the mandatory ratio would continue to fetch them zero interest, and cutting the key repo rate in fact helps them better to reduce cost of funds.

“I don’t understand this discussion on CRR or the cash reserve ratio that sometimes comes up...this is a question that some bankers raise occasionally, saying cut CRR. I think it should be recognised that CRR is primarily a monetary instrument,” Rajan told analysts and researchers at a post-policy con-call.

It can be recalled that Mr. Rajan had in April termed the demand for CRR cut as ‘irrelevant’. Even after this, Indian Banks Association (IBA) Chairman and head of State-run Indian Bank T.M. Bhasin had called for a CRR cut.

“If you want to reduce the cost of capital and reduce lending rates, the more direct instrument to use is the policy rate which we have used,” Mr. Rajan said, adding that a 1 per cent cut in the CRR would help improve a bank’s cost of funds by 0.08 per cent, while similar reduction in the repo rate had the potential to reduce it by an equal measure.

The Governor added that the mandatory cash reserve ratio (CRR), under which the banks have to park 4 per cent of their deposits with the RBI as a mandatory solvency measure, would continue to fetch no interest for them.

“It is absolutely necessary to keep it uncompensated because that is the way we essentially drive the monetary policy transmission through the credit multiplier,” he said.

“We have surplus liquidity in the system as there has not been much credit offtake so repo window does not give banks any advantage as we don’t borrow from banks at this point. So, the CRR window helps us bring down cost of funds.

“We expect and will request 0.5 per cent cut in CRR which would release about Rs.40,000 crore in the system,” Mr. Bhasin said. He repeated the same in a statement in his reaction to the policy on Tuesday.

Retorting to this, Mr. Rajan said, “which is more beneficial? A 25 bps (repo cut) or a 25 bps CRR cut that the bankers keep talking about. Clearly, it is the 25 bps cut in the policy rate. I don’t understand this discussion on CRR that sometimes comes up.”

SBI had been repeatedly lobbying for a CRR cut and there was a very strong exchange of words between the past SBI Chairman Pratip Chaudhuri and the former RBI Deputy Governor K.C. Chakrabarty regarding the same. Mr. Chaudhuri had even demanded abolition of the CRR terming it as dead money."

RBI Governor's view is puzzling and apparently obstinate. RBI can consider reducing CRR alongwith a drop in Repo rate. It is not an either-or issue. If Cash Reserve Ratio is brought down from the existing 4% , banks will have more funds to lend and therefore interest rates for borrowers will come down. RBI's intransigence on CRR is self-defeating. It is not an issue of which instrument (CRR or Repo rate) is more beneficial or more powerful. RBI needs to look at them as complementary tools.