MC Explains | All you need to know about the Incremental Cash Reserve Ratio

Experts believe that there will be no major impact on the deposit and lending rates because RBI Governor Shaktikanta Das said that the central bank will ensure there is adequate liquidity in the system.

The Reserve Bank of India (RBI) on August 10 said that scheduled banks have to maintain an incremental cash reserve ratio (I-CRR) of 10 percent on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28.

The central bank added that the existing cash reserve ratio (CRR) remains unchanged at 4.5 percent.

So, why this I-CRR? We will try and explain below.

Difference between I-CRR and CRR

I-CRR is similar to the CRR, wherein banks need to set aside a certain portion of their money with the RBI. They do not earn any interest on this. Likewise, with the I-CRR, banks need to set aside an additional 10 percent of the NDTL garnered between May 19 and July 28.

Why has the RBI announced the I-CRR?

The central bank has announced the I-CRR with an aim to manage the higher surplus liquidity sloshing about in the economy following the return of Rs 2,000 notes to the banking system (after they were withdrawn from circulation).

“This measure is intended to absorb the surplus liquidity generated by various factors, including the return of Rs 2,000 notes to the banking system,” RBI Governor Shaktikanta Das said at the press conference following the monetary policy committee meeting.

In the last few months, the liquidity in the banking system has risen sharply post the withdrawal of Rs 2,000 banknotes, the transfer of RBI’s surplus to the government, an uptick in government spending, and capital inflows.

To mitigate this, the central bank has conducted various variable rate reverse repo (VRRR) auctions of different tenures, but received a muted response from the banks, as they preferred holding on to the liquidity to avoid seeking funds later under the Marginal Standing Facility (MSF). The MSF allows banks to borrow from the RBI in emergencies at a rate higher than the repo.

Since June, the central bank has conducted 16 VRRR auctions for Rs 18 lakh crore. However, banks parked only Rs 7,73,023 crore in these auctions.

How much money will be parked in I-CRR?

Das said that per the RBI’s internal calculations, a little over Rs 1 lakh crore will be parked in I-CRR, which will accordingly lower the surplus liquidity in the banking system, which currently stands at around Rs 2.11 lakh crore.

According to Esha Khanna, Associate Professor, NMIMS Sarla Anil Modi School of Economics, this move may slightly tighten the liquidity situation in the short term and affect short-term call rates.

How will it impact systemic liquidity?

Most money market dealers and experts said the I-CRR will have some impact on the banking system liquidity, but it will continue to be in surplus by over Rs 1 lakh crore for the next couple of months.

“An ICRR of 10 percent can take out a little over Rs1 lakh crore from the banking system. Despite this, the system liquidity will remain in surplus by more than Rs 1 lakh crore for the next 1-2 months,” said Pankaj Pathak, Fund Manager-Fixed Income, Quantum AMC.

But the I-CRR will impact short-term rates, which may harden by 15-20 basis points (bps).

“We expect the short-term rates of money market instruments like treasury bills, call money rates, and commercial paper to increase by 15-20 bps in the near term,” said Anil Gupta, Senior Vice President, Co-Group Head - Financial Sector Ratings, ICRA Ltd.

Will it impact lending and deposit rates?

Experts believe that there will be no major impact on the deposit and lending rates because the RBI Governor has said that the central bank will ensure there is adequate liquidity in the system.

“We will ensure there is enough liquidity in the system for banks to continue lending,” Das said during the conference.

Will RBI continue VRRR auctions?

Das also clarified that even though the central bank has announced the I-CRR, VRRR auctions will continue to be the main tool for draining excess liquidity.

“VRRR (auctions) will continue,” Das said, adding that the VRRR system will release about Rs 93,000 crore on August 10.