The country needs to move towards a situation where Cash Reserve Ratio (CRR) level comes down and that it is used as an instrument of “credit control” only in extraordinary conditions, said C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, on Thursday.

As “Open market operations (OMOs) became increasingly major instrument….The role of CRR, as credit control, will come down,” said Dr. Rangarajan while talking to presspersons on the sidelines of the FICCI-IBA banking conference here.

CRR is the proportion of deposits banks must set aside with the Reserve Bank of India (RBI).

Last month, State Bank of India had sought scrapping of CRR, which stands at 4.75 per cent.

While talking on CRR as a monetary instrument, he said that prior to 1991 CRR was the major instrument of credit control because interest rate was administered and, therefore, OMOs could not be conducted and, therefore, CRR remained the major or the only instrument of credit control available with the RBI.

In fact, at that time, CRR continued to be raised to very high levels because the budget deficits were high and it was being financed by the RBI and, therefore, to contain liquidity growth, CRR needed to be raised to very high levels.

However, said Dr. Rangarajan, “at the time of the banking sector reforms, we took a conscious view to reduce the CRR and, therefore, it has been progressively brought down.”

While speaking on the topic ‘The Indian banking system — some issues’, Dr. Rangarajan said that if the Indian banking system was to remain competitive over time, there should be periodic entry of new banks . “A closed system can only become oligopolistic. The ‘threat’ of entry should not, therefore, be eliminated, and the central bank should lay down entry norms as also decide on who satisfies the criterion of fit and proper,’’ he said

“It must be noted that new banks take about two decades to achieve a sizable level”, said Dr. Rangarajan, adding, “Our decision on how many new banks to be licensed must be based on what the economy will need - not today but over the next several decades.” Further, he said that banks needed to watch out for liquidity risks which would increase because of maturity mismatches. “Increased exposure to real estate and infrastructure will lengthen the maturity of bank assets.” He said that Indian banking system was also exposed in a big way to certain sectors such as power and aviation which were not doing well.

“The challenge for banks lies in efficiently managing risks both in the upswing and downswing.”

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