Introduction
The Reserve Bank of India (RBI) announced on September 8, 2023 that it would discontinue the incremental cash reserve ratio (I-CRR) because of an assessment of current and evolving liquidity conditions. The RBI also decided to release the amount under the I-CRR in a phased manner so that system liquidity is saved from sudden shocks. This measure was intended to absorb the extra liquidity due to the return of Rs 2000 notes to the banking system and some other factors.
What is Cash Reserve Ratio?
It is the amount of cash that the scheduled commercial banks are required to maintain with the RBI with respect to their net demand and time liabilities (NDTL) on a fortnightly basis. One of the basic reasons for keeping CRR with the RBI is to provide safety to the public deposits so that banks do not exhaust all of their deposits and have a safety net in times of need. CRR also helps banks address the issues of liquidity demand, when customers demand cash. CRR cannot be used to lend or to invest. It is kept with the RBI.
When the RBI feels that there is excess liquidity in the economy, it increases the CRR to absorb the excess liquidity. Thus, the interest rates and the lending rates of banks also increase. As a result, people save more money and spend less. So, the deposits increase. On the other hand, when RBI feels that there is less liquidity, it decreases the CRR. A decrease in CRR discourages deposits, so people tend to save less and spend more, leading to an increase in liquidity.
Incremental cash reserve ratio (I-CRR) It is the additional amount of cash that can be asked by the RBI for the banks to maintain over and above the CRR for a specific period of time. This measure majorly helps absorb the excess liquidity in the economy and prevents price fluctuations and instability. I-CRR is a purely temporary measure to absorb the excess liquidity in the banking system. It has a short-term impact.
In comparison, other monetary policy instruments such as the repo rate, reverse repo rate, open market operations, liquidity adjustment facility (LAF), marginal standing facility (MSF), and SLR (statutory liquidity ratio) have a long-term and extended impact on the economy.
Background
In August 2023, RBI Governor Shaktikanta Das announced the monetary policy and asked the banks to maintain an I-CRR of 10 per cent on the increases in their NDTL between May 19, 2023 and July 28, 2023. This was to manage the excess liquidity in the banking system. The excess liquidity led to an increase in government spending and capital inflows. However, it also negatively impact prices leading to inflation which could disrupt financial stability.
Due to the RBI recommendation, the banking system’s liquidity temporarily went into a deficit on August 21, 2023, but turned in surplus starting from August 24, 2023. Therefore, RBI planned to discontinue the I-CRR mandate in phases—25 per cent of I-CRR was discontinued on September 9; another 25 per cent, on September 23; and the remaining 50 per cent, on October 7, 2023. It would avoid market disruptions and make sure the banks have enough liquidity to meet higher demands during the festive season.
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