[Economy] Cash Reserve Ratio (CRR) Controversy between SBI & RBI: meaning, implication on Economy Explained

[Economy] Cash Reserve Ratio (CRR) Controversy between SBI & RBI: meaning, implication on Economy Explained

  1. What is CRR?
  2. What is Scheduled Commercial Bank?
  3. Examples of Scheduled Commercial Banks
    1. Case #1: High CRR and SLR
    2. Case #2: Low CRR and SLR
  4. Repo Rate
  5. Reverse Repo Rate
  6. Bank Rate
  7. What is the need of all these CRR,SLR,Repo rates?
  8. What is the problem with CRR?
  9. How much CRR deposit does RBI have?
  10. What does SBI want?
  11. Deputy Governor of RBI
  12. Timeline of Events
  13. Mock Questions

What is CRR?

  • CRR means Cash Reserve Ratio.
  • Banks in India are required to hold a certain proportion of their total deposits with RBI in cash form.
  • Right now, CRR is about 4.75% that means if people deposit total Rs.100 in SBI, then SBI would have to deposit Rs.4.75 in RBI.
  • This is CRR or Cash Reserve Ratio.
  • CRR rule doesnot apply to Non Banking Financial Companies (NBFC), Mutual funds or insurance companies.

What is Scheduled Commercial Bank?

  • Scheduled banks are those banks which have been included in the second schedule of the Reserve bank of India act of 1934.
  • The banks included in this schedule list should fulfill two conditions.
  1. The paid capital and collected funds of bank should not be less than Rs. 5 lakhs.
  2. Any activity of the bank will not adversely affect the interests of depositors [hahaha, does it mean Non-scheduled banks are allowed to adversely affect the interests of depositors !?]

Examples of Scheduled Commercial Banks

Public Sector Private Sector
Majority of stake is held by the government.

  1. State Bank of India (SBI)
  2. Punjab National bank (PNB)
Majority stakes are held by private players.

  1. ICICI,
  2. HDFC,
  3. AXIS Bank

Case #1: High CRR and SLR

Suppose total deposit deposited in (by you and me) State Bank of India =Rs.100

Total Deposit Rs.100
CRR: 15%SBI has to park this much amount of total deposit in RBI, without getting any interest. -15
SLR: 38%SBI has to park this much amount of total deposit, in Government securities / treasury bonds. SBI earns around 7.5% interest rate on this investment. -38
Money left with SBI 100-15-38=Rs.47

Case #2: Low CRR and SLR

Total Deposit Rs.100
CRR: 4.75%SBI has to park this much amount of total deposit in RBI, without getting any interest. -4.75
SLR: 23%SBI has to park this much amount of total deposit, in Government securities / treasury bonds. SBI earns around 7.5% interest rate on this investment. -23
Money left with SBI 100-4.75-23=Rs.72.25

In either case, as long as you’re running a bank, you’ll have some input costs such as

  1. Salary to Bank PO , Clerks, peons and security guards (With rusted guns)
  2. Office rent
  3. ATM machine’s electricity and maintenance.
  4. Newspaper advertizements.

To pay above salary and bills, SBI would need to maintain certain amount of profit margin, no matter what RBI does with CRR,SLR or Repo Rate.

In Case#1, when SBI has only Rs.47 in the hands, what can it do to keep the profit margin same?

Obviously SBI will have to increase the interest rates on car,home,bike,business loans given to customers.

In case#2, when SBI has Rs.72, what can it do? Here the situation is not that bad.

So, SBI chief would decrease the interest rates on car,home,bike,business loans to seduce more customers. We already discussed this- SBI has more money so it can cut down interest rates and suffer temporary reduction in profit, in order to seduce more customers (compared to ICICI) So once SBI has reduced the interest rates, other banks will need to reduce their interest rates, to stay in the competition.

Repo Rate

Let’s continue assuming the Case#2, that SBI has only Rs.72.25 left in its locker.

  • SBI chief comes to know that recently Samsung Company has launched Galaxy S3 mobile so plenty of youngsters may want to buy it because of the advertisements that appear on TV channels 24/7
  • Thus there will be demand for more personal loans (EMI) or credit card based shopping. But SBI got only Rs.72.25.
  • So SBI chief would borrow some more money from RBI @8% interest rate and then re-lend this money to customers as personal loan @16% (and thus making a killing profit of 16-8=8%)
  • or he can supply money to customers for Credit Card shopping, and in that case he can earn interest rate anything between 16-37% or even more (depending on hidden terms and conditions of credit card.)
  • This 8% : the rate @which RBI lends short term loans to clients, is called Repo Rate.

Reverse Repo Rate

  • As the name suggests, Reverse repo rate is “reverse” of Repo rate.
  • So, if SBI chief feels there is not enough demand for loans and most of those 72.25 Rupees are sitting idle, he’ll deposit some of that cash, in RBI.
  • RBI will pay SBI chief 7% interest rate on such deposit.
  • Thus, Reverse repo rate is the interest rate which RBI pays its clients* for their short-term deposits.
  • Note: Reverse Repo Rate is automatically kept 1% less than Repo rate according to new RBI rules. [Since Nov.2010, Reverse Repo rate is constantly 1% less than Repo].

Side Question

Why would SBI chief put his money in RBI?
Because on your normal savings account in SBI, the chief pays you around 4% interest rate, while RBI is giving him 7% Reverse repo rate, so he’s making a profit of 3%.

Bank Rate

  • Bank rate is the interest rate which RBI charges from its clients* for their LONG-term loans.
  • Recall that Repo Rate = RBI charge that much interest from its clients on SHORT term loans.

*Who’re the clients of RBI?

  1. Union Government
  2. State Government
  3. NABARD (through that money goes to Microfinance companies and Regional Rural Banks)
  4. Commercial Banks (SBI, ICICI etc)
  5. Non Banking Financial Companies (NBFC) like Muthoot Finance and Mannapuram Gold Loans.

(^list is not exhaustive.)

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