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Should CRR be Abolished

Time and again many Bankers and economists have recommended scrapping of CRR. With Banks facing rising NPA in recent years, demand has again been raised my few experts to scrap CRR.

What is CRR?

• The banks in India are required to hold a certain proportion of their deposits in form of cash with the Reserve Bank of India (RBI). This minimum ratio stipulated by the RBI is known as CRR.

• Cash Reserve Ratio (CRR) is ratio of reserves at which commercial banks must hold or deposit with the central Bank. In other words it is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults or as deposits made with the central bank. This reserve can be maintained either in cash, gold or unencumbered government securities.

• The RBI is empowered to prescribe CRR for scheduled banks without any floor rate or ceiling rate, keeping in view the needs of securing monetary stability in the country. Higher the CRR, lower the banks will be able to use for lending and investment.

• The reserve requirement, on one hand, helps the bankers to have enough cash to meet any crisis and on the other hand, they serve as tools for Central Bank to control the liquidity in the system in order to manage the Inflation. When CRR is altered then the interest rates will be changing as per availability of funds with the commercial banks.

Why CRR should be abolished

• All banks put together maintained a cash balance of Rs3,14,900 crore with the RBI every day, and this keeps on growing with the growth in deposits of the banking industry. This humungous amount does not earn any interest for the banks. If you calculate the interest on this amount at the average lending rate of banks, say at 10%, the total loss to the banking industry is in excess of Rs31,000 crore per year.

• According to many Bankers CRR policy had denied the country growth, and its abolition would allow banks to lower the lending rate.

• Since the RBI did not pay any interest, the CRR acted like a tax on the banking system, placing the banks at a competitive disadvantage versus non-banking financial companies and mutual funds who do not require to pay CRR.

• According to experts, the loss to the banking sector due to CRR was Rs 21,000 crore.

• If a bank falls short of its CRR requirements, the RBI collects interest on the shortfall from the bank at the bank rate as if the defaulting bank has borrowed that money from the central bank. While the RBI's action is justified, as it is the only way the central bank can enforce discipline among the banks, this is a source of irritation to the Banks.

• Most of the central banks in developed countries have dispensed with the system of CRR and have been using the tool of open market operations to control inflation.

Why it should not be abolished?

• CRR system is synonymous to us keeping some cash with us, family or friends etc for a rainy day. 

• Till the time the rainy day does't come this is just blocked fund which is not put to full use but when and if the day comes you are more than happy you kept it. 

• Now CRR serves a similar purpose - surely banks and thereby customers have to bear the cost but it comes at the price of increased safety.

• CRR and SLR are two Safety Valves built in the system by prudent bankers to protect banks from all types of adversities. Safety Valve in pressure cooker provide safety to cook when he or she forgets taking due care before cooking through pressure cooker. It is but natural that due to natural calamities or due to adverse business environment or due to global reasons banks have to face huge cash demand from depositors and liquidity crunch from time to time.  If CRR and SLR is abolished or reduced from present level, these banks will go fail and depositors will face the consequences arising out of faulty credit decisions of bank officials

• If a bank falls short of its CRR requirements, the RBI collects interest on the shortfall from the bank at the bank rate as if the defaulting bank has borrowed that money from the central bank. While the RBI's action is justified, as it is the only way the central bank can enforce discipline among the banks, this is a source of irritation to the SBI.

• Few years ago RBI had ceased to pay interest rate on CRR, which affects the commercial banks. This is one of the main reasons why SBI chairman wanted CRR to be abolished.

Way ahead

• With the rising non-performing assets of the banking industry, growing number of accounts falling under the hammer of corporate debt restructuring, dwindling margins of commercial banks and the strain on their profitability, there is every justification for the commercial banks to clamor for marked reduction in the CRR, However scrapping CRR is not a solution since CRR is needed as safety valve for the Financial system. However interest should be paid on CRR so that Banks do not consider it as burden.

 

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