The Reserve Bank of India (RBI), in its monetary policy review directed banks to uphold an incremental Cash Reserve Ratio (ICRR) of 10 percent on the augmented deposits registered between May 19 and July 28.
What is ICRR?
Banks are mandated to maintain a certain proportion of their deposits and specific liabilities as liquid cash with the RBI, which is called as cash reserve ratio. This serves as a mechanism for the RBI to regulate liquidity in the economy and act as a buffer during periods of financial strain. Presently, banks are required to retain 4.5 per cent of their Net Demand and Time Liabilities as CRR with the RBI.
The RBI possesses the authority to impose an incremental credit reserve ratio in addition to the CRR, particularly during periods of surplus liquidity in the system. This means that banks will be obligated to park a higher amount of liquid cash with the RBI.
What are the key features of ICRR?
The RBI outlined in its monetary policy that effective from August 12, 2023, all scheduled banks must uphold an additional cash reserve ratio equating to 10 per cent of the surge in their net demand and time liabilities (NDTL) recorded between May 19, 2023, and July 28, 2023.
Curing this period, the RBI announced the discontinuation of Rs 2,000 notes, leading to substantial deposit inflows in banks. The RBI’s intention is to absorb some of this liquidity from the system.
The central bank is assuring banks that this measure is temporary, with a review of the ICRR scheduled for September 8, 2023. If liquidity equilibrium is reinstated by then, the RBI might return the impounded funds to the banks prior to the festival season, ensuring minimal impact on credit growth.
What is the potential amount flowing to RBI through ICRR?
Assuming a conservative estimate, the value of Rs 2,000 notes in circulation amounted to Rs3.56 lakh crore by May 19, 2023. The RBI reported that approximately 88 per cent of these notes had returned to banks by end of July 2023. A significant portion of these notes has been converted into deposits in banks.
Taking into account that around 85 per cent of the money was deposited in banks, the surge in deposits due to these notes would approximate Rs 2.6 lakh crore. A 10 per cent requirement would result in the RBI impounding approximately Rs 26,000 crore as ICRR.
This sum could be larger if liquidity injected through forex operations is considered. Moreover, some banks might have allocated the incremental deposits in alternative avenues, leading to a potential ICRR amount ranging from Rs 20,000 crore to Rs 40,000 crore.
What will be the impact of ICRR?
RBI’s primary objective is to curtail inflation through this tool. As liquidity is withdrawn, banks will have limited funds for lending, thereby decreasing demand for goods and services, and consequently reducing prices.Short-term interest rates might rise due to tightening of fund supply in the economy, acting as an additional measure to counter inflation. The introduction of an incremental CRR may tie up bank resources and exert upward pressure on market rates.
While bankers will evaluate the impact, the temporary shocks can’t be ignored as bankers are expecting an impact of up to an amount of Rs 1 lakh crore. Impact on NIMs will be minimal since the duration is only for a month. Also, currently, underlying growth is strong, credit growth is also strong,” a banker said.
How will ICRR add to pressure on banks?
Many banks including the State Bank of India have witnessed a considerable compression on their margins in the first quarter of FY 23-24. On the other hand, there is also pressure on the deposit growth of banks. Amidst this, the pink note deposits were a breather for banks.
Anitha Rangan, Economist, Equirus, said, “In view of the surplus liquidity and perhaps to deliver an implicit hike (of lesser impact), RBI has temporarily increased the CRR levels by 10 per cent of incremental NDTL of banks. This in effect takes out the 10 per cent of surplus accumulated from Rs 2,000 note withdrawal and FX operations (Rs 30,000-35,000 crore).
