Plan to cut interest on cash balances to hit banks

The earnings of banks will be dented if a proposal to drastically pare the interest on eligible cash balances under the cash reserve ratio (CRR) is implemented.

An RBI internal group has proposed that this interest rate be brought down from the present bank rate (6 per cent) to a rate lower than the repo rate (4.5 per cent). If the proposal is implemented, the interest burden of the apex bank on account of CRR will come down.

The group felt that the remuneration on eligible cash balances under CRR at its present level is not justifiable. It has argued that 'no remuneration is appropriate to make CRR most effective".

Considering the present situation, the group has proposed that such remuneration should be delinked from the bank rate and placed at a rate lower than the repo rate.

CRR is the amount of money and liquid assets that banks must hold in cash or deposit with the RBI. It is a specified percentage of their net demand and time liabilities (NDTL) and is used by the regulator to manage liquidity in the banking system.

CRR is currently pegged at 4.5 per cent of a bank's NDTL. While the first three per cent of a bank's NDTL does not earn any interest, the quantum of funds maintained in excess of three per cent and up to 4.5 per cent of NDTL fetch a six per cent interest (bank rate).

Funds parked with the RBI in excess of 4.5 per cent of NDTL do not earn any interest. Banks report to the regulator every fortnight on their CRR maintenance.

Consider an example of the possible impact of this proposal. A bank having an NDTL of Rs 20,000 crore will need to maintain a CRR of Rs 900 crore on a fortnightly basis.

It earns no interest on Rs 600 crore (3 per cent of NDTL), while the balance Rs 300 crore (1.5 per cent of NDTL) fetches a return of Rs 18 crore at a 6 per cent interest per annum. Suppose the interest rate on the balance Rs 300 crore was to be pared to 4 per cent, then the bank would earn Rs 12 crore, which is Rs 6 crore less.

Big banks earn anywhere between Rs 100 crore and Rs 200 crore by way of interest on their balances with the RBI and other interbank funds.