Chidambaram helps banks to cut rates with nod for CRR interest

The Union finance ministry, which could not persuade the central bank to cut policy rates, is exploring other means to help ease lending rates in an attempt to spur investment and consumption in a weakened economy. Official sources told FE the ministry asked the Reserve Bank of India (RBI) a fortnight ago to consider resuming interest payments on bank deposits with the central bank. The matter was taken up at the highest level, these sources said.

If the central bank pays 8% — the current repo rate — interest on money banks keep with it, lenders could get Rs 22,000 crore. This is in addition to the Rs 17,500 crore released to banks after the RBI cut the cash reserve ratio (CRR) by 25 basis points at Tuesday's half-yearly monetary policy review. The extra liquidity, the ministry reckons, will help banks reduce lending rates.

As on October 19, total deposits of all scheduled banks (SCBs) were R65.7 lakh crore. At the current CRR of 4.25%, banks must keep around R2.8 lakh crore with the central bank.

An 8% interest on this means additional funds of Rs 22,000 crore at the banks' disposal.

Though the central bank used to pay interest to SCBs on CRR balances maintained by them, the practice was stopped from March 31, 2007 following an amendment to RBI Act, 1934. In order to resume interest payments, sources said, there is no need to amend the Act, as the legislation doesn't explicitly prohibit interest on CRR funds, but merely says it isn't incumbent on the RBI to pay it. The amendment's intention was to accord the central bank operational flexibility on the CRR front in line with international practices.

Though banks do not earn any interest on CRR funds, these fetch returns for the central bank.

Recently, SBI chairman Pratip Chaudhuri publicly demanded abolition of CRR, while RBI deputy governor KC Chakrabarty chided Chaudhuri for his alleged disregard for regulatory norms. Even after the latest policy review, Chaudhuri maintained that CRR is waste for the economy, and a burden on banks.

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