Phasing Out Cash Reserve Rato : May Usher In Risk & Lead To Loss Of Confidence

SBI  Chairman Pratip Chaudhri  has made a pitch for phasing out the Cash Reserve Ratio(CRR) as according to him it pushes up the cost of funds for the industry.(Business Line, August 24, 2012). Speaking at  a FICCI Banking Conclave at Kolkota  on August 23, he said that the 4.75% of deposits mobilized does not earn any income and that the balance resources will have ‘to earn  for the rest( to make up for the loss of interest on CRR) which is leading to a cost increase  for the industry without benefiting anybody.’(BL) .

He also tries argue his case  by mentioning that  banks have to block a large quantum of money , close to Rs.21,000 crores,in a capital scarce econmy which needs funds for developmental projects.He is of the opinion that the SLR requirement is sufficient to address the liquidity and solvency issues.Of course, Mr.Chaudhuri also felt that RBI should pay interest on CRR till the CRR as such is phased out.

While apparently the banking industry is likely to support the SBI chairman’s plea for removing the CRR requirements, one may wonder  why the SBI Chairman is so much concerned about it.If he is worried about his own bank’s performance  because of the CRR stipulation, there is not much of  reason in it.Because, the entire banking industry, with which SBI is likely to be compared on performance, is subject to the CRR requirements.

While SLR acts as a cushion for bank’s liabilities, they are subject to market fluctuations.Hence, to decide on that only SLR will be sufficient, may not be right.Also, the perfect functioning of the banking system requires unbridled trust of the public who entrust their savings with the banks.And, the CRR acts as a foundation for that trust.It might also be remembered that the current levels of CRR are far below those that were in vogue about two decades earler.And, we always have been very proud that our banking suystem  has very strong foundations, compared to that in the west where a number of banks fail every year, thanks to the wonderful role played by RBI, the banking regulator.

While the suggestion that RBI pay interest on CRR money it keeps makes sense,the call for doing  away with the CRR could be a call at least for ushering risk  and losing confidence in the Indian banking system, if not  disaster.His concern for the so-called capital scarcity(to the tune of only  Rs.21,000 cr)  is not necessarily well-founded considering that the capital markets in India has been functioning in a  robust manner.