Context:
Liquidity Position Trend Since the second half of December 2024 Indian banks have faced a liquidity deficit that touched a level of 236 trillion as on January 20 2025.
This liquidity deficit was partly caused by an accumulation of government cash balances with the Reserve Bank of India and RBI interventions in the forex market which drained rupee liquidity.
- RBIs Policy Response
- The liquidity deficit reduced CRR to banks by RBI in December 2024 as much as it 50bps downline was reduced to as low as to 40 to NDTL.
- The resultant effect is expected around 116 trillion liberated into the banks coffers to address concerns that a liquidity deficit creates.
- Current Status on CRR Issue
- Bankers have pointed out that reducing the CRR further can supply yet more durable liquidity.
Role of CRR in Liquidity Management
- The role of the CRR in management of liquidity can be seen from the following two viewpoints:
- Smoothing short term interest rates by absorbing sudden inflows or outflows of funds in settlement balances helps manage intraday liquidity needs and relieves pressure on overnight interbank call money rates.
- Managing large or sudden capital inflow/outflow In emerging markets, like India, providing a cushion in managing large or sudden capital inflow/outflows is important.
Historical Evolution and Effectiveness of CRR Changes
- In times of crisis such as the 2008 North Atlantic Financial Crisis and the 2020 COVID19 crisis the RBI reduced the CRR significantly to inject liquidity quickly into the system.
- 2008 CRR was cut by 4 percentage points to 5 to provide liquidity.
- 2020 The CRR was reduced sharply to 3 to respond to pandemic related disruptions.
- However CRR has been permitted to fall below 4 only during crisis times The March 2020 reduction was an exception.
Risks of Further CRR Cut
- Limitations on Further CRR Cuts
- CRR is currently at 4 the current level of CRR is at a critical point CRR cuts cannot be made at this point in time unless the circumstances are dire enough to call for such extreme action.
- Transitory liquidity factors
- The current deficit is partly because of temporary factors and the liquidity adjustment facility by the RBI can cater to such needs without any further cuts in CRR.
- Alternative measures
- The RBI has other instruments like OMOs and targeted liquidity operations to handle liquidity effectively without any further cuts in CRR.
- Challenges of Other Instruments
- OMOs Although effective OMOs are relatively slower and may not offer quick liquidity They do involve participation constraint and could thus distort government bond yields.
- CRR Flexibility
- Reducing the CRR enables the RBI to inject liquidity more quickly and uniformly across all banks compared with OMOs which take their time and are much less flexible.
