How RBI is responsible for banks’ biggest NPA

Source :First Post :R Jagannathan :Jan 11, 2012



The Reserve Bank of India (RBI), at its meeting with bankers on Tuesday, is believed to have indicated that it is not in favour of cuts in the cash reserve ratio (CRR) – the cash banks have to lock up with the RBI for no return.


The central bank apparently is wary about sending the wrong signals to the markets – that inflation has been conquered, when that is far from being the case.


Deputy Governor Subir Gokarn said last week that though rates may have peaked, it would not be right to conclude that a “quick reversal” to easy money policies was on the cards.


The RBI is believed to have indicated that it is not in favour of cuts in the cash reserve ratio (CRR) – the cash banks have to lock up with the RBI for no return. AFP
At Firstpost, we have always argued that inflation is not a dying threat. In fact, we may be in for long-term food inflation for want of the right policies on the supply front apart from fiscal profligacy.


However, CRR isn’t the best way to run monetary policy in the current scenario, where liquidity is tight, and banks are raising deposits at high costs. In the process, profitability is under pressure just when they need to provide more for bad loans.


With several sectors – textiles, aviation, real estate, and power, to name just a few – seeing bad times, there is a strong probability of a good chunk of assets in these sectors turning bad. A Firstpost computation shows banks’ exposure to risky sectors at more than Rs 9,00,000 crore.


Moreover, daily demand for funds from the RBI continue to remain high at the repo auctions at over Rs 1,00,000 crore. The RBI has indicated that anything over Rs 60,000 is indicative of tight liquidity.


Given that the next three months constitute the traditional busy season for Indian business, the challenge before the RBI is to ease liquidity without giving up its vigil on inflation.


This is where CRR comes in. For three reasons.


A 0.5 percent cut in the CRR will improve liquidity by Rs 25,000 crore. Not enough to completely ease the tightness in the market, but good enough to give banks some relief from costly money.


Since the government’s borrowings might well exceed the Rs 93,000 crore of additional debt issues already announced, banks will need more money in their pockets to subscribe to these securities.


Third, and most important, CRR is banks’ biggest NPA – non-performing asset. Six percent of their net demand and time liabilities (deposits) are locked up in CRR without any interest (or very little of it for older balances).


The bottomline is this: does the RBI want banks to lose money on its account?


It’s time to start reducing banks’ worst non-paying assets in stages to 3 percent. Six percent is way too high.


Over to you, Mr Subbarao. Cutting CRR is the best way to signal reasonableness without suggesting you have gone soft on inflation.