There is a fundamental flaw in the argument that the Reserve Bank should make it attractive for banks to place funds under the CRR requirement. Banks are already keeping securities in excess of the SLR requirement at the cost of lending to various sectors which is the primary function of banks. The skill and efficiency of banks are seen in managing risk in their lending operations and earning income even while keeping a check on the NPAs. It is difficult to accept the comparison made with the interest paid by the RBI on Market Stabilisation bonds when the excess liquidity caused by the inflow of foreign exchange is withdrawn. It would be interesting to know the response of Shri A. Seshan to this article as he has a wealth of knowledge on the subject.
- A.Chandramouliswaran (via e-mail)
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I agree with the comments of Shri Chandramouliswaran. I thank him for the suggestion that I should contribute to the debate on the payment of interest on CRR balances flowing from the article under reference. I have already argued for not paying interest as the banks are making money through the working of the money multiplier (See “Nothing for banks to gripe about”, Business Line, September 11,2012 and the subsequent article “Government gets it wrong on CRR” of November 7,2012.) The question of paying interest on CRR balances does not arise, as the system is amply rewarded by the power to create money out of thin air. Obviously, in such matters, while the RBI looks at the system, individual banks think in terms of the bottom lines of their balance sheets. That the banks and the system will benefit more from a lower CRR with no interest payment than a higher CRR with interest payment has been pointed out by other experts on the subject. If the interest is to be paid on balances with RBI what will be the role of the reverse repo rate? The first part of the statement that “SLR is primarily aimed at restricting the expansion of bank credit as also to ensure solvency of banks” is not correct. Investments in SLR also contribute to the working of the money multiplier when government spends its balances with the RBI. There is no difference between credit and investment so far as the money multiplier is concerned.
The Market Stabilisation Scheme was introduced to sterilise the inflows of foreign currency mopped up by the RBI by selling rupees through intervention undertaken to stabilise the value of the domestic currency. Who would have bought those bonds without interest payment? Unlike OMO where the banks have a choice to participate or quote their own terms, CRR works across the system like a blunt tool and is more effective than the former. The author argues that an interest rate of 8-9 per cent will make it attractive for banks to park money in the central bank. What will be its impact on the market rate for government securities?
In the USA thanks to the three versions of Quantitative Easing the system is flooded with liquidity. The created money is making a round trip to the Fed. Due either to the reluctance to lend on risk aversion or the lack of demand for credit, banks find the interest of 0.25 per cent on total balances with the Fed more attractive than investment in Treasury Bills. As on September 14, 2012, the yields on one-month, three-month, six-month and one-year Treasury Bills were 0.08, 0.11, 0.13 and 0.18 per cent, respectively (See “Will the Fed’s QE 3 work?”, A. Seshan, Business Standard, September 20,2012). Banks’ total cash reserves with the Fed amounted to $1.55 trillion on September 5, 2012, of which 93.5 per cent was excess. This is what will happen if the suggestion of the article is implemented. It may lead to an acute shortage of liquidity and credit and destabilise the money market.
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