Cash Reserve and Liquidity Ratios_ a Primer

8/9/2019 Cash Reserve and Liquidity Ratios_ a Primer

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Cash Reserve and Liquidity Ratios: A Primer

This is a guest post by Dheeraj Singh. Dheeraj is a former fund manager for many years

specializing in fixed income. Used to head fixed income at IL&FS Mutual Fund (before it got

taken over by UTI) and subsequently worked with Sundaram BNP Paribas Mutual Fund

(now Sundaram Mutual Fund) heading the fixed income desk. He runs Finanzlab Advisors, atreasury and risk management consultancy.

Table of Contents

Introduction

CRR The Cash Reserve Ratio

SLR Statutory Liquidity Ratio

Net Demand and Time LiabilitiesWhat constitutes NDTL?

NDTL Base for CRR and SLR

Demand Liabilities

Time Liabilities

Other demand and time liabilities (ODTL)

Inter Bank Assets

Liabilities not to be included in DTL / NDTL calculation

NDTL Computation

CRR Maintenance

The nitty gritty of CRR maintenance

Reporting Friday and Reporting Fortnight

Penalties

SLR Maintenance

Specified Investments

Penalties

Footnote

Introduction: The Reserve Ratios A Primer

Cash Reserve Ration(CRR) and Statutory Liquidity Ratio (SLR) are two important reserve

ratios applicable to banks. These are also tools that the Reserve Bank of India uses in the

conduct of its monetary policy.

The purpose of this primer is to provide a working knowledge and understanding of these

reserve ratios. The content of this primer is based on RBIs Master Circular on the subject

and my own practical knowledge gained through the many years that I have been involved


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with the money and debt markets as a fund manager. Errors and Omissions if any are

entirely mine. If you do spot any errors, please let me know in the comments.

CRR The Cash Reserve Ratio

CRR is that proportion of a banks Net Demand and Time Liabilities (NDTL) that it has to

keep as cash deposits with RBI. Cash deposits do not mean physical cash, but a creditbalance in a current account that every bank maintains at RBI.

This proportion is specified by RBI and could change from time to time. Currently (on the

date this piece is being published), CRR is 4.75%.

CRR is governed by the provisions of Section 42 of the Reserve Bank of India Act, 1934.

There is no minimum level of CRR. We could go upto zero CRR (negative values are ofcourse absurd). Similarly, there is no maximum. In theory, CRR can go upto 100%, which

would mean RBI impounding the entire NDTL as a cash reserve.

Until the RBI Act was amended in 2007, the minimum value of CRR was statutorily fixed at

3% and the maximum was fixed at 20%. Both these limits (lower and upper) were removed

by the amendment which came into effect in early 2007.

SLR Statutory Liquidity Ratio

SLR is that proportion of a banks Net Demand and Time Liabilities (NDTL)that it has to

maintain as investments in certain specified assets. SLR is governed by the provisions of

Section 24 of the Banking Regulation Act.

There is no minimum stipulation on SLR (earlier there used to be a minimum stipulated SLR

of 25% but this was removed with an amendment to the Banking Regulation Act in 2007).

However, SLR can not exceed 40%.

Net Demand and Time Liabilities

It is quite apparent that to arrive at CRR or SLR we need to first calculate NDTL.

What constitutes NDTL?

As the name suggest there are three broad components to NDTL.

Demand Liabilities

Time Liabilities; and


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A Netting Amount that is reduced from the Demand and Time Liabilities.

Additionally Demand and Time Liabilities (DTL) are further broken up into

DTL to the banking system;

DTL to Others; and

Other DTL.

RBI has been empowered to decide on what kind of liabilities fall under DTL. In case of

doubt, banks are advised to get a clarification from RBI.

NDTL Base for CRR and SLR

Is CRR and SLR maintained on the same base viz NDTL?

The short answer is, No.

While the NDTL calculation is broadly the same, there are some important differences when

it comes to its use to compute CRR and SLR.

Some items are exempt for CRR purposes and so, the base on which CRR is to be

maintained is not the same as the base on which SLR is computed. We shall look at these

differences in the base a little later.

Demand Liabilities

Demand Liabilities of a bank are liabilities which are payable on demand. These include

current deposits;

demand liabilities portion of savings bank deposits;

margins held against letters of credit / guarantees;

balances in overdue fixed deposits;cash certificates and cumulative/recurring deposits;

outstanding Telegraphic Transfers (TTs);

Mail Transfer (MTs);

Demand Drafts (DDs);

unclaimed deposits;

credit balances in the Cash Credit account; and

deposits held as security for advances which are payable on demand.

Time Liabilities

Time Liabilities of a bank are those liabilities that are payable other than on demand.


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These include

fixed deposits;

cash certificates;

cumulative and recurring deposits;

time liabilities portion of savings bank deposits;

staff security deposits;margin held against letters of credit, if not payable on demand;

deposits held as securities for advances which are not payable on demand; and

gold deposits.

Other demand and time liabilities (ODTL)

ODTL includes:

interest accrued on deposits;

bills payable;

unpaid dividends;

suspense account balances representing amounts due to other banks or public;

net credit balances in branch adjustment account;

Cash collaterals received under collateralized derivative transactions.

Any amounts due to the banking system which are not in the nature of deposits or borrowingare also to be included in other demand and time liabilities. Such liabilities may arise due to

items like (i) collection of bills on behalf of other banks, (ii) interest due to other banks and so

on

Inter Bank Assets

Assets with the banking system include

balances with banks in current account;

balances with banks and notified financial institutions in other accounts;

funds made available to banking system by way of loans or deposits repayable at call

or short notice of a fortnight or less; and

loans other than money at call and short notice made available to the banking system.

Any other amounts due from banking system which cannot be classified under any of the

above items are also to be taken as assets with the banking system.

Liabilities not to be included in DTL / NDTL calculation

The following liabilities are not be included in the DTL calculation for purposes of maintaining


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CRR and SLR

Paid up capital, reserves;

Any credit balance in the Profit & Loss Account of the bank;

Amount of any loan taken from the RBI;

Amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI;

Net income tax provision;Amount received from Deposit Insurance and Credit Guarantee Corporation (DICGC)

towards claims and held by banks pending adjustments thereof;

Amount received from ECGC by invoking the guarantee;

Amount received from insurance company on ad-hoc settlement of claims pending

judgment of the Court;

Amount received from the Court Receiver;

The liabilities arising on account of utilization of limits under Bankers Acceptance

Facility (BAF);

District Rural Development Agency (DRDA) subsidy of Rs.10, 000/- kept in Subsidy

Reserve Fund account in the name of Self Help Groups;

Subsidy released by NABARD under Investment Subsidy Scheme for

Construction/Renovation/Expansion of Rural Godowns;

Net unrealized gain/loss arising from derivatives transaction under trading portfolio;

Income flows received in advance such as annual fees and other charges which are

not refundable;

Bill rediscounted by a bank with eligible financial institutions as approved by RBI;

Provision not being a specific liability arising from contracting additional liability and

created from profit and loss account.

NDTL Computation

Computation of NDTL is a multi step process as follows :

Compute Demand Liabilities to the banking system

Compute Time Liabilities to the banking system

Take the sum of the above two to arrive at DTL to the Banking System (A)

Compute Demand Liabilities to others

Compute Time Liabilities to others

Take the sum of the above to arrive at DTL to Others (B)

Compute Other Demand and Time Liabilities (C)


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Calculate Assets to the banking system (D)

ComputeNet Inter Bank DTLby subtracting Assets to the Banking System from DTL to the

banking system -(A-D)

If the Net Inter Bank DTLso calculated is negative or zero, it is ignored.

Thus NDTLis given by

NDTL= (A-D)+(B+C) if A-D is greater than zero,

NDTL= B+C if A-D is less than or equal to zero.

CRR Maintenance

Items on which CRR maintenance is exempt:

Banks are exempted from maintaining CRR on the following liabilities:

Liabilities to the banking system in India.

Credit balances in Asian Clearing Union (US$) Accounts.

Demand and Time Liabilities in respect of their Offshore Banking Units (OBU)

For CRR purposes, NDTL should not include inter-bank term deposits / term borrowingliabilities of original maturities of 15 days and above and up to one year. Similarly banks

should exclude their inter-bank assets of term deposits and term lending of original maturity

of 15 days and above and up to one year for calculating inter bank assets (which is used to

net off DTL and arrive at NDTL). The interest accrued on such deposits should also not be

included.

As a consequence of the above, CRR is not maintained on

Net Inter Bank DTL;

Non Resident Deposits (NRE and NRNR);

FCNR (B) Short term and Long term;

Exchange Earners Foreign Currency (EEFC) accounts;

Resident Foreign Currency Accounts;

Escrow Accounts by Indian Exporters;

Foreign Credit Line for Pre-Shipment Credit Account;

Overseas rediscounting of bills;Credit Balances in ACU (US dollar) Account;

The nitty gritty of CRR maintenance


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Banks maintain CRR on a fortnightly average basis.

Say, a bank has NDTL of 100 croresand CRR is 5%.

The bank will thus have to maintain 5 croresas cash balance in its account with RBI. This 5

crores is calculated on a fortnightly average basis and the exact modality of how this is done

is explained below.

Reporting Friday and Reporting Fortnight

To understand how this fortnightly average system works, we need to first understand the

concept of reporting fortnight and reporting Friday.

Every alternate Friday is a reporting Friday. As I write, the last reporting Friday was March

23, 2012. So the next reporting Fridays would fall on April, 6, April 20, May 4 and so on. In

case the reporting friday happens to be a holiday, the last previous working day is taken as

the relevant reporting friday.

The 14 day period beginning on the Saturday immediately following a reporting Friday is

called a reporting fortnight. A reporting fortnight therefore begins on a Saturday and ends on

the reporting Friday.

As the name would suggest, banks report their business numbers (deposits, advances,

investments etc.) to RBI as on these reporting Fridays.

For purposes of maintaining CRR and SLR, banks have to calculate their NDTL on every

reporting friday.

However, the actual CRR and SLR maintenance happens with a lag of one fortnight.

So if the NDTL of a bank was 100 crores on March 9, 2012 and (assuming CRR is 5%) the

bank would have to maintain an average cash balance of 5 crores in the reporting fortnight

which begins on March 24.

This reporting and maintenance cycle is repeated over.

The situation can be better understood in the depiction below


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Assume A, B and C are dates on a timeline that fall on alternating Fridays. Also, lets say

these are reporting Fridays.

Lets also say that a bank calculates its NDTL on A and it turns out that the NDTL is equal to

100 crores.

If the CRR is 5%, the bank has to maintain an average cash balance of 5 crores over a

fortnight. However, banks are given one fortnights time before they start maintaining these

CRR balances.

So, for NDTL of 100 croreson A, the bank would have to maintain an average cash balance

of 5 croresduring the reporting fortnight BC.

To implement this, banks maintain CRR by the fortnightly product method.

Once again, it is easier to understand this with an example.

Lets take our previous example:

If the bank has to maintain 5 crores on an average over the fortnight (14 days) it effectivelyhas to maintain a product of

5 x 14 = 70 crores

Banks also have to maintain at least 70% of their stipulated CRR average as cash balance

with RBI on every day of the reporting fortnight. This means that the bank in our example

has to maintain

0.70 x 5 = 3.5 croresas cash balance on every day of the fortnight.

Lets say for e.g. that the bank maintains the following cash balances on the first seven days


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of the fortnight.

Day 1 : 4 crores

Day 2 : 4.5 crores

Day 3 : 3.5 crores

Day 4 : 7 Crores

Day 5 : 6 croresDay 6 : 5.5 crores

Day 7 : 6.5 crores

Effectively the bank has maintained a product of

4 + 4.5 + 3.5 + 7 + 6 + 5.5 + 6.5 = 37 croresin the first 7 days.

(To calculate the product we multiply the amount maintained by the number of days the

amount is maintained as balance. Since we are taking daily amounts we simply multiply the

amounts by a factor of 1)

This means that the bank now needs to maintain only 70-37 = 33 crores as product in

the second week of the reporting fortnight.

The minimum 70% stipulation means that banks can maintain neither too low a cash balancenor too high a cash balance on every day of the fortnight. If they maintain too high a cash

balance during the initial days of the fortnight, it may so happen that the product build up is

rapid and the bank may need to maintain a significantly lower cash balance during the last

few days of the fortnight. This condition could lead to a breach of the minimum 70% rule

which could incur penalties.

Banks thus have to be diligent in the calculation and maintenance of their fortnightly product.

Until this 70% rule was brought in sometime in 2002, banks were free to maintain any

amounts, with the result that volatility in the money market was high, as banks requirement

of funds varied sharply depending on their product build up during the reporting fortnight.

Penalties

From the fortnight beginning June 24, 2006, penal interest will be charged as under

In case of default in maintenance of CRR requirement on a daily basis which is presently 70

per cent of the total CRR requirement, penal interest will be recovered for that day at the rate

of:


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Bank Rate + 3% per annumon the amount by which the cash balance

actually maintained falls short of the prescribed minimum on that day.

If the shortfall continues on the next succeeding day/s, the penal interest

levied is at the rateBank Rate + 5% per annum.

In cases of default in maintenance of CRR on average basis during a fortnight, penal interest

will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act,

1934. Under this section,The penal interest for default is:

if the average daily balance held at RBI by a bank during any fortnight is below the required

average balance for CRR purposes, penal interest will be charged at the rate of

Bank Rate + 3% per annum

on the amount by which the balance falls short of the requirement.

If during the next succeeding fortnight the daily average balance is still below the required

amount, the penal interest liable to be charged is

Bank Rate + 5% per annum

for each subsequent fortnight during which the bank defaults on maintaining the minimum

required balance.

In addition to the above if the default on maintaining CRR continues for more than two

fortnights meaning then any director, manager or secretary who knowingly and wilfully is a

party to such defaults are liable to be fined a princely sum of five hundred rupees for everyfortnight where such default occurs.

More tellingly if such a default on CRR continues for more than two fortnights, RBI has the

power to prohibit the bank from accepting any fresh deposit.

The relevant clause in the RBI Act also says that if the bank contravenes this stipulation of

not accepting any fresh deposit, then any manager, director or secretary who wilfully and

knowingly is a party to such an action shall be fined a princely sum of five hundred rupees.

Of course, we know that RBI can take drastic action under other laws and these small fines

(of five hundred rupees) stipulated in the RBI Act carry little meaning in the real sense.


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SLR Maintenance

As has been discussed above, SLR is that proportion of NDTL that the bank has to maintain

in certain specified assets.

It should be noted that for SLR purposes NDTL is calculated slightly differently.

Firstly, all inter bank liabilities and assetsare to be included for SLR purposes (unlike

CRR wherein liabilities with original maturity between 15 days and one year were excluded)

Secondly, there are no exemptions(items on which no SLR is to be maintained) unlike

CRR where some items are exempt.

Specified Investments

The specified investments that are eligible for SLR purposes are

Cash

Gold valued at a price not exceeding the current market price

Investment in the following instruments which will be referred to as Statutory

Liquidity Ratio (SLR) securities:

Dated government of india securities

Treasury Bills of the Government of India;

State Development Loans (SDLs) of the State Governments issued from time to time

under the market borrowing programme; and

Any other instrument as may be notified by the Reserve Bank of India.

Of the above, any securities which are encumbered in any way can not be included for SLR

purposes. This also includes situations wherein the security may have been submitted to

RBI as collateral under the daily liquidity adjustment facility (the commonly understood RBI

repo window).

Unlike CRR which is maintained as an average over the entire fortnight, SLR has to be

maintained on all the days of the relevant fortnight.

The relevant fortnight and NDTL are however the same as in the case of CRR.

SLR is therefore maintained on the NDTL as on the reporting Friday of two fortnights ago.

(just like in the case of CRR).

Penalties

If a bank fails to maintain the required amount of SLR, it shall be liable to pay to RBI in


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respect of that default, penal interest for that day at the rate of three per cent per annum

above the Bank Rateon the shortfall.

If the default continues on the next succeeding working day, the penal interest may be

increased to a rate of five per cent per annum above the Bank Ratefor the concerned

days of default on the shortfall.

Footnote:

In my opinion, the bank ratecontinues to exist only because of the penalty provisions on

default in maintenance of reserve requirements.

Had these penalty provisions not been linked to the bank rate under the law, we would have

possibly seen the demise of the bank rate as an instrument of monetary policy.

Under the current situation doing away with the bank rate would require amending the RBI

Act and the Banking Regulation Act something that only the Parliament can do. Amending

laws take significant effort, and therefore we might have to live with the bank rate for some

more time.

RBI has anyway made the bank rate irrelevant by equating it to the rate at which it lends

money under the marginal standing facility (MSF). MSF is currently pegged at one percent

above RBIs repo rate.

Update: It seems I may have been a bit enthusiastic in predicting the demise of the bank

rate. Sec 372A of the Companies Act says that companies can not lend to each other at an

interest rate lower than the bank rate. So RBIs increase in bank rate ensures that inter

corporate loans or investment in bonds can only be made if the coupon rate is at least the

bank rate. Of course there are ways around this provision if one is structuring a deal.

However, this just goes to show, how laws enacted ages ago, need to change with the

times. Im sure RBI probably did not intend to regulate the rate of interest paid out in the intercorporate loans market (or maybe they actually did), when they changed the bank rate

recently and linked it to the marginal standing facility rate.

Cash Reserve and Liquidity Ratios_ a Primer

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