CRR harsh on public sector banks

Be the change you wish to see, said the Mahatma. But talking publicly about the change you want to see can be perilous to you if you are a banker — no matter how big a banker you are. The recent controversy caused by the statement on CRR by the Chairman of India’s biggest bank amply demonstrates this. SBI Chairman, Pratip Chaudhury wants to see a change — a change in the CRR, which according to him has outlived its purpose, and so has to be phased out.

The CRR is simply locked up in the vault, does not get ploughed back into the economy, does not give any interest to the banker, and increases the pressure on the banker to earn more from the remaining resources — these are the arguments he put forward. The response he got from the RBI was along expected lines, though not in the expected words.

Is CRR regulation such an infallible doctrine that it cannot be amended?

CRR is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults, or as deposits made with the central bank. In India, a certain percentage of the demand and time liabilities has to be kept as cash balance with the RBI, as per Section 42(2) of the RBI Act, 1934. This is in addition to the Statutory Liquidity Ratio (SLR), stipulated as per Section 24 of the Banking Regulation Act, 1949.

This reserve can be maintained as cash, gold or unencumbered approved securities. On the one hand, reserve requirements help the bankers to have enough cash to meet any eventuality.

On the other hand, they serve as tools in the hands of the regulator for controlling the liquidity in the system, thereby managing inflation. Alterations in the reserve requirements also influence interest rates by changing the funds available with the banks for lending.

ALTERNATIVES TO CRR

Cash reserves are no longer mandatory in many advanced countries. Australia, New Zealand, Canada, Sweden, have done away with it.

The UK has a system of voluntary CRR. In the US, CRR is calculated only on transaction accounts (checking accounts). The Euro Zone has a low CRR of 1 per cent.

At the other end, Pakistan, Bangladesh, Sri Lanka, Zambia and Mexico stipulate higher rates of CRR than ours. All BRIC countries still hold on to CRR and make periodical alterations to affect the liquidity. Except in countries with underdeveloped banking systems, the purpose of CRR is not safety, but liquidity. The emphasis has moved to capital adequacy ratios from CRR in many countries, as far as safety is concerned.

In India, banking is not what it was in 1934 or 1949. With the nationalisation of the major commercial banks in 1969 and 1980, the ownership and risk profile of banks in the country have undergone a sea change.

A major share of banking business in the country is handled by banks where the majority shareholder, if not the sole shareholder, is the government. Further, capital adequacy and income recognition norms are well established as per international standards.

The reference rates and open market operations are available with the regulator as tools to control money supply. Have we not reached a stage where we can review CRR?

BANKS IN A BIND

Banks in India, particularly the public sector banks, have an unenviable task to perform. NPAs have been mounting and the provision norms for restructured accounts will make matters worse. Stricter priority sector lending norms, such as that for direct agriculture lending, will further enhance the stress on margins.

On the one hand, the RBI Governor does not allow a reduction in reference rates for fear of inflation. On the other hand, the Finance Minister wants the interest rates to the borrower to be lowered. This can be done either by reducing the interest rates on deposits or by reducing banks’ profit margin. Even with the existing higher rates, deposit growth is slow in view of the low or negative real returns, and due to increased flow of funds to real-estate and gold.

Settling for a reduction in the profits will put further pressure on capital, particularly in view of the Basel III regulations to be implemented shortly. The government as the major shareholder will have to pump in more money. The concern expressed by the SBI Chairman at this stage is understandable.

DIFFERENTIAL CRR

Phasing out the CRR should be a distinct, even if distant goal. But what can be examined at this juncture is whether the CRR prescription is to be applied to all banks uniformly, irrespective of ownership.

The RBI can think of classifying banks into specific categories for CRR, say, banks with 100 per cent Government ownership, banks with more than 51 per cent government ownership, private sector banks and foreign banks — and stipulating different rates for different categories, with the necessary amendments to the RBI Act.

The CRR may be fixed at a lower level for the first two categories, in view of the higher safety level these banks offer to the depositors.

Higher levels of CRR can be fixed for the new entrants in the private sector, compared with the existing ones, for a specific period.

A differential rate of CRR will provide a better level playing ground for the public sector banks that are expected to play a more active role in social banking. It may be noted that the private sector banks are outperforming public sector banks in profitability.

(The author is former Deputy General Manager, Syndicate Bank.)