Tinkering with CRR to enhance banks’ liquidity is not without risk (The Hindu)

Mains Paper 3: Economy
Prelims level: Net demand and time liabilities
Mains level: Liquidity in banking sector

Context:

• As part of the sixth bi-monthly Monetary Policy Statement (2019-20), the Governor of the Reserve Bank of India stated that the Monetary Policy Committee has decided to continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.

Relaxing the cash reserve ratio rate:

• To accommodate banks, the RBI has relaxed its cash reserve ratio (CRR) prescription in an indirect way, without actually reducing the CRR rate.
• Accordingly, scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed as retail loans for automobiles, residential housing and loans to MSMEs from their net demand and time liabilities (NDTL), over and above the outstanding level of credit to these segments, as at the end of the fortnight ended January 31, 2020, for the maintenance of the CRR.
• It has been explicitly stated that this provision is prescribed to revitalise the flow of bank credit to productive sectors, which may have multiplier effects to support impulses of growth.
• This means that instead of diverting the funds for CRR maintenance by banks, they may be used to address the credit requirement of the focussed sectors.

Implications of tinkering:

• All scheduled banks have deposits (beyond other banks) of ₹1,35,30,581.43 crore as on January 17, 2020. The banks are supposed to maintain a CRR of 4 per cent on this amount, ie ₹5,41,223 crore.
• As per the revised policy, banks can reduce their CRR balance from any incremental increase in credit to the focussed sectors. Hence, they can comfortably release additional funds to the tune of ₹5,41,223 crore. This is significant liquidity created by the RBI.
• As the RBI does not pay any interest on CRR, any loans availed through this liquidity facility will increase profitability for the banks. The cost of these funds can be technically taken as zero.
• This exemption will be available for incremental credit extended up to the fortnight ending on July 31, 2020. Hence, we may witness aggressive disbursal by banks in the coming days.

NPA risk:

• As banks’ cost of funds will technically be zero, there will be cut-throat competition to lend, which may result in poor credit assessment. Reckless lending will lead to more NPAs piling up in the future.
• It is not clear how the CRR will be calculated after July 31.
• Will banks be allowed to continue to reduce the loan already disbursed up to that date for CRR requirement? Or will this exemption be totally removed?
• If so, the sudden CRR requirement will present a big challenge for the banks.
• Where willbanks get the funds to maintain adequate CRR, if the exemption is totally removed after July 31?

Conclusion:

• The CRR prescription ensures sufficient safety and liquidity for the banks.
• Making use of the CRR to enhance lending by banks is a double whammy, as it will, on one hand, increase the banks’ vulnerability, as well as reduce the safety of banks through the CRR mechanism on the other.
• However, quality lending under this new liquidity facility may enhance profitability for banks.

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Prelims Questions:

Q.1) Which of the following proposed by the working group, put in place Securities and Exchange Board of India (SEBI) changes to strengthen the regulatory framework for related-party transactions that have been the subject of many corporate governance matters?
1. Broaden the definition of RPTs (related-party transactions) to include transactions which are undertaken, whether directly or indirectly, with the intention of benefitting related parties.
2. An audit committee approval must be made mandatory for transactions between a listed entity or its subsidiary with its related party.
3. Any entity related to the promoter or promoter group should be considered a related party.

Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1, 2 and 3 only
(d) None

Answer: C
Mains Questions:
Q.1) The RBI’s move to indirectly relax the CRR prescription will boost the lending capability of scheduled banks. Do you think it can increase the subsequent competition can lead to reckless lending? Comment.