Banks' cash reserves may not yield interest

Commercial banks may not get any interest on their deposits kept with the Reserve Bank of India (RBI) in the form of cash reserve ratio (CRR). RBI Governor YV Reddy presented the central bank's mid-year review of the monetary policy on October 24 at a bankers' meet where his deputy Rakesh Mohan had flagged off the CRR issue.

Mohan did not give any timeframe for the withdrawal of interest on the CRR but invited bankers' views on the proposal. Bankers did not offer any comment on the spot but in private they said if the RBI did not want to pay any interest on the CRR, the regulator should dismantle the system.

The proposal "" if it goes through "" will hit banks' income. A bank's chairman said, "In a sense, the CRR is a non-performing asset (NPA) as we get very little interest on it. On top of that, if the RBI wants to abolish interest on the CRR, banks will be hit hard." For every rupee kept under the CRR, banks lose money as interest paid on the CRR is much less than their cost of funds.

Banks' CRR is now pegged at 5 per cent of their net demand and time liabilities. It was 4.5 per cent until September 2004 when the RBI raised the level by 50 basis points (one basis point is one hundredth of a percentage point) to 5 per cent in two stages.

Under existing norms, the CRR "" which is a direct impoundment of cash by the RBI "" cannot be brought down below 3 per cent. The other reserve requirement "" the SLR (statutory liquidity ratio) "" is now at 25 per cent.

In September last year, the RBI delinked the interest rate on the CRR from the bank rate. From September 18, 2004, banks have been paid interest at a rate of 3.5 per cent per annum on their eligible cash balances maintained with the RBI under the CRR requirement.

Until that time, banks were paid 6 per cent (bank rate) on the CRR balance kept with the RBI.

An internal group on liquidity adjustment facility in the RBI had recommended in December 2003 lower interest rates on the CRR.

Earlier, former RBI Deputy Governor SS Tarapore made a strong pitch for not offering any interest to banks on their CRR balance kept with the RBI. However, commercial banks have always been fighting for a higher rate on the CRR.

In its annual monetary and credit policy of 2002-03, the RBI had said it would continue to pursue its medium-term objective of reducing the CRR to its statutory minimum of 3 per cent.

However, the RBI said it would retain the option to use the CRR in both directions for liquidity management, as and when essential.