India’s banking system has slipped into liquidity deficit for the first time in the current fiscal year, a consequence of the Reserve Bank of India’s (RBI) temporary liquidity reduction measures and tax outflows.
The banking system had initially enjoyed a surplus of Rs 2.8 lakh crore at the start of the month, but this situation has shifted due to the RBI’s directive for banks to uphold an incremental cash reserve ratio (I-CRR) of 10% on the increase in deposits between May 19 and July 28. This initiative has led to the withdrawal of over Rs 1 lakh crore from the system.
The RBI’s decision to withdraw the Rs 2,000 currency note, announced on May 19, prompted individuals to either exchange or deposit these notes. As of July 31, approximately 88% of the Rs 2,000 banknotes in circulation, amounting to Rs 3.14 lakh crore, had been reintroduced into the banking system.
I-CRR decision
Following the Monetary Policy Committee (MPC) meeting, RBI Governor Shaktikanta Das unveiled the decision to implement an incremental cash reserve ratio (I-CRR) of 10% on the growth of net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023, effective from August 12, 2023. Das clarified that this measure aims to absorb the surplus liquidity stemming from various factors, including the return of the Rs 2,000 notes, and is a temporary strategy to manage liquidity excess.
This I-CRR policy will be subject to review on or before September 8, 2023, with the intention of restoring the withheld funds to the banking system before the festive season. It is noteworthy that the regular cash reserve ratio (CRR), which mandates the portion of funds that banks must maintain with the RBI, remains unchanged at 4.5%.
In explaining the rationale behind the incremental CRR, Governor Das had stressed its necessity due to the liquidity surplus resulting from factors such as the reintroduction of the 2,000 rupee notes, the RBI’s surplus transfer to the government, increased government expenditure, and capital inflows. The monthly absorption under the liquidity adjustment facility (LAF) reflected figures of Rs 1.7 lakh crore in June and Rs 1.8 lakh crore in July 2023.
In a parallel historical context, the RBI had previously instituted a 100% I-CRR on augmented net demand and time liabilities (NDTL) of scheduled banks in November 2016. This move aimed to absorb excess liquidity following the withdrawal of the Rs 500 and Rs 1,000 notes.
