The central bank’s decision to increase the cash reserve ratio (CRR) to 100 per cent on deposits received between September 16 and November 11 is likely to stem a slide in interest rates, as liquidity will be drained out of the banking system, economists said.
Banks do not earn any interest on their CRR balances maintained with the RBI.
Deposits with the banks rose by more than Rs.5 lakh crore following the withdrawal of high-value currencies as customers rushed to banks to deposit the withdrawn notes. The deadline for such deposits is December 30.
Lenders such as State Bank of India (SBI) and ICICI Bank had reduced deposit rates by 10-15 basis points after deposits swelled following the withdrawal of the Rs.1,000 and Rs.500 notes.
“Bond yields could see a knee-jerk reaction of about 15 basis points and the reduction in lending and deposit rates might halt for now,” economists at Citi India said in a research note. The yield on the 10-year benchmark government bond climbed 10 basis points to 6.33 per cent. Bond yields fell to 6.23 per cent on Friday, lower than the repo rate of 6.25 per cent.
“If banks were able to keep these deposits and deploy them as per the existing allocation between credit and investments after providing for 4 per cent CRR, gross earnings would be Rs.25,205 crore and net earnings after adjusting for the cost of deposits would be around Rs.7,100 crore. This may be assumed to be the opportunity cost of these funds for a full year,” CARE Ratings said in a note explaining the impact on the banks due to the CRR hike.
Shares fall
Following the increase in CRR, shares of public sector banks such as SBI, Punjab National Bank, Union Bank of India, Bank of Baroda all fell between 2 and 3 per cent, while the benchmark Sensex closed marginally higher.
Now all eyes are on the next bi-monthly policy review of RBI scheduled on December 6 and 7 and the expectation for a rate cut is growing since the demonetisation drive is seen as slowing economic growth.
“We expect the RBI to cut rates aggressively in December up to 50 basis points. Our expectation of a sub-3.5 per cent inflation rate in Nov/Dec now looks sacrosanct,” said Soumya Kanti Ghosh, chief economic advisor, SBI in a note.
“The loss to GDP will significantly widen the output gap, a perfect foil for cutting rates, in RBI’s words. Clearly, the banking sector is in challenging times,” Mr. Ghosh said.
