Currency withdrawal: Reserve Bank throws CRR googly at banks, borrowers

Currency withdrawal: Reserve Bank throws CRR googly at banks, borrowers

By making banks deposit Rs 3,24,000 crore with the Reserve Bank, the cost for banks on these deposits would be Rs 18,110 crore on an annual basis as this has to be paid to the customers.

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Containers with currency being carried, outside a bank in Chandigarh. (Express Photo: Kamleshwar Singh)

The Reserve Bank of India (RBI) has virtually thrown a spanner in the works of banks, markets and borrowers with its decision to impound the deposits mobilised by banks after demonetisation of high value notes. While the Reserve Bank has said the move to impose 100 per cent incremental cash reserve ratio (CRR) on such deposits is a temporary measure, bankers and analysts are not sure whether the widely expected cut in interest rates by the central bank will still materialise on December 7.

If the RBI maintains the CRR at 100 per cent for a longer period, banks will soon have to start counting their losses. That’s because the CRR — which is the portion of deposit to be compulsorily deposited with the RBI — doesn’t earn an interest. As CRR balances earn zero interest from the RBI and the central bank uses it as a money supply tightening tool, it’s a loss-making proposition for banks. “By making banks deposit Rs 3,24,000 crore with the RBI, the total cost for banks on these deposits would be Rs 18,110 crore on an annual basis as this has to be paid to the customers. If these terms on CRR are diluted in course of time, the cost would come down commensurately,” said a report by Care Ratings.

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Under normal circumstances, if banks were able to keep these deposits and deploy them as per the existing allocation between credit and investments after providing for 4 per cent CRR — which is the normal CRR— gross earnings would be Rs 25,205 crore and net earnings after adjusting for the cost of deposits would be around Rs 7,100 crore. This may be assumed to be the opportunity cost of these funds for a full year. Additionally, banks which fall short of the stipulation will be penalised at the rate of 3-5 per cent above the bank rate which is 6.75 per cent depending the extent of the deviation from the norm over a sustained period of time.

However, the major impact will be on the monetary policy as a widely expected cut in repo rate may not happen in the monetary policy review on December 7. Former RBI Governor, D Subbarao, who was the RBI Governor from 2008 to 2013, had said demonetisation of high denomination notes is likely to lead to lower interest rates. Banks will see their cost of funds declining even in the absence of any further policy easing by the RBI, encouraging them to reduce lending rates and pump credit into the economy. “Now we have to wait and see how the situation evolves in the coming days,” said a State Bank of India official.

Will monetary transmission happen? Many market participants had assumed that higher banking sector liquidity in the wake of the surge in deposits would mean faster transmission to lower bank lending rates. 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 per cent interest rate to savings account depositors, but will be not be receiving any interest on the deposits impounded for CRR,” says a Crisil report.

India Ratings said after the current measures, the markets’ expectation of a rate cut in the upcoming monetary policy review could also face a downward revision, further weighing down on the bond market. This could lead to the widening of spreads between Government securities and corporate bonds, as near term investor appetite will remain weak. The RBI’s prognosis on downside to growth due to demonetisation will be the key factor driving the repo rate decision on December 7. Since the last monetary policy review in October, the downside risks to growth have risen and that the ratio of that to inflation have subsided. “The fall in the value of rupee could exert some upward pressure on the imported component of inflation. We believe the odds are in favour of a 25 bps repo rate cut to 6 per cent,” Crisil said.

In the next two days, a total of Rs 1.72 lakh crore will be coming back into the system. Moreover, RBI also announced variable rate repo auction of whopping Rs 3 lakh crore. Thus, the system liquidity will remain comfortable. Communication regarding forward guidance in terms of what constitutes “reactive policy” based on market developments and decisions based on the medium term outlook must be given by RBI. “We expect the RBI now to cut rates aggressively in December up to 50 basis points. Our expectation of a sub 3.5 per cent inflation rate in November/ December now looks sacrosanct. This will be consistent with a lower term structure of interest rates that will enormously benefit the banks at least in treasury gains for better provisioning when they have been entrusted with the onerous task of mobilising the entire accretion in yearly deposits in less than 2 months. Additionally, the loss to GDP will significantly widen the output gap, a perfect foil for cutting rates, in RBI words. Clearly, the banking sector is in challenging times,” said Soumya Kanti Ghosh, chief economic advisor, SBI.

While banks were mopping up huge deposits, many experts had cautioned that it comes with its limits as significantly lower lending rates over a short period of time cannot be taken for granted. “One, as soon as enough new notes are printed (i.e. remonetisation is complete) and withdrawal limits raised, much of the new deposits could leave the banks. Two, the RBI would have had a preference to suck out temporary super-normal liquidity increases. And since Saturday’s incremental CRR hike, the banks will also not be earning interest on the additional deposits, given CRR is non-remunerative. Under these circumstances, if the RBI believes than lending rates need to fall over time, in order to support growth and recovery, (especially given some growth drag following demonetisation), cutting the repo rate may provide a nudge. We are expecting a repo rate cut in the December 7 policy meeting,” said Pranjul Bhandari, chief India economist, HSBC.

After the surge in deposits, the 10-year benchmark 6.97 per cent yield has been on a free fall since November 9, touching 6.23 per cent on November 25, or 2 basis points below the repo rate of 6.25 per cent. This has not only inverted the yield curve (longer yields lower than shorter ones, and perceived as less risky), but made it difficult for the RBI to further cut the repo rate during its upcoming monetary policy review on December 7, Crisil said.


Net FII outflows from the Indian debt market was $2.4 billion in two weeks up to November 25. The 10-year G-sec yield fell nearly 60 bps, while the US equivalent rose over 40 bps, spurring FII outflows, leading to the sharp depreciation in the rupee.