The Reserve Bank of India (RBI) has recently announced its decision to phase out the Incremental Cash Reserve Ratio (I-CRR).
What is Cash Reserve Ratio (CRR)?
CRR represents a percentage (currently at 4.5%) of the total deposits that banks are required to maintain as liquid cash with the RBI. This mechanism ensures that banks always have enough cash on hand to meet the payment demands of depositors. In essence, CRR acts as a safety net for depositors since banks cannot utilize this cash for lending or investment purposes.
What is I-CRR?
I-CRR, on the other hand, is an additional cash balance that the RBI can request banks to maintain, above and beyond the regular CRR, for a specified period. In August 2023, as part of the monetary policy announcement, the RBI Governor specified that banks must maintain an I-CRR of 10% on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023. NDTL refers to the total demand and time liabilities (deposits) of the public held by banks with other banks.
Necessity of I-CRR
The introduction of I-CRR was necessitated by the presence of excessive liquidity in the banking system, which could pose risks to both price and financial stability. It is essential to continuously assess the level of surplus liquidity and take additional measures as required to absorb excess liquidity. I-CRR served as a temporary measure to achieve this by absorbing the surplus liquidity, attributed to factors such as the return of Rs 2,000 banknotes, RBI’s surplus transfer to the government, increased government spending, and capital inflows. The RBI Governor estimates that I-CRR absorbed over Rs 1 lakh crore of excess liquidity from the banking system.
Discontinuation of I-CRR
However, after the introduction of I-CRR, the liquidity in the banking system shifted from surplus to deficit for the first time in the fiscal year on August 21. Liquidity, as indicated by the RBI’s injection into the system, amounted to Rs 23,644.43 crore on August 21. Subsequently, liquidity returned to surplus from August 24, with the RBI absorbing Rs 76,047 crore of surplus liquidity from the system on September 8. The tight liquidity conditions were partly influenced by GST outflows and the central bank’s intervention to stabilize the falling rupee. In light of this, the RBI has decided to discontinue the I-CRR in a phased manner.
Phased Release of Impounded Amounts
To ensure the orderly functioning of money markets and prevent sudden shocks to system liquidity, the RBI has outlined a schedule for the release of amounts impounded under the I-CRR. On September 9, 25% of the funds maintained under I-CRR will be released. This will be followed by another 25% on September 23, and the remaining 50% will be released on October 7.
This phased release of impounded funds ensures that banks have adequate liquidity to meet the increased credit demand expected during the upcoming festival season.
UPSC Mains Questions
- Why did the RBI introduce the Incremental Cash Reserve Ratio (I-CRR)? What was its primary objective, and how did it impact the banking system’s liquidity?
- What factors contributed to the need for phasing out the I-CRR, and why did the banking system experience shifts from surplus to deficit liquidity during its implementation?
- How does the phased release of impounded amounts under the I-CRR contribute to the stability of the money markets, and why is it timed strategically for the festival season?
- What broader implications might the discontinuation of the I-CRR have on India’s monetary policy and the banking sector’s operations in the future?
