REDUCTION OF SLR AND CRR

The Narasimham Committee had argued for reductions in SLR on the grounds that the

stated government objective of reducing the fiscal deficits will obviate the need for a

large portion of the current SLR.

Similarly, the need for the use of CRR to control secondary expansion of credit would be

lesser in a regime of smaller fiscal deficits.

However bankers strongly felt that CRR and SLR along with high non-performing assets

(on which banks do not earn any return) which were 10 per cent CRR and 25 percent

SLR in the past were affecting banks' bottom lines.

The committee offered the route of Open Market Operations (OMO) to the Reserve Bank

of India for further monetary control beyond that provided by the (lowered) SLR and

CRR reserves.

The monetary policy perspective essentially looks at SLR and CRR requirements (especially

CRR) in the light of several other roles they play in the economy. The CRR is considered an

effective instrument for monetary regulation and inflation control. The SLR is used to impose

financial discipline on the banks, provide protection to deposit-holders, allocate bank credit

between the government and the private sectors, and also help in monetary regulation. However

bankers strongly feel that these along with high non-performing assets (on which banks do not

earn any return) 10 per cent CRR and 25 per cent SLR (most banks have SLR investments way

above the stipulation) are affecting banks' bottom lines. With an effective return of a mere 2.8

per cent, CRR is a major drag on banks' profitability. The Narasimham Committee had argued

for reductions in SLR on the grounds that the stated government objective of reducing the fiscal

deficits will obviate the need for a large portion of the current SLR. Similarly, the need for the

use of CRR to control secondary expansion of credit would be lesser in a regime of smaller fiscal

deficits. The committee offered the route of Open Market Operations (OMO) to the Reserve

Bank of India for further monetary control beyond that provided by the (lowered) SLR and CRR

reserves. Ultimately, the rule was Reduction in the reserve requirements of banks, with the

Statutory Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-97 in a period of 5

years. The recent trend in several developed countries (US, Switzerland, Australia, Canada, and

Germany) towards drastic lowering of reserve requirements is often used to support the argument

for reduced reserve levels in India.

The arguments for higher or lower SLR and CRR ratios stem from two different perspectives one

which favours the banks, and the other which favours the bank reserves as a monetary policy

instrument. The bank perspective seeks to maximise "lendable" resources, the banks' control over

resource deployment, and returns to the banks from the "preempted" funds. It is also claimed that

the low returns from the forced investments in government securities adversely affect the bank

profitability - the cost of deposits for banks, which averages at 15 16 per cent, was much greater

than the (earlier) returns on the government securities. This argument is sometimes carried

further to state that RBI makes profits on impounded money, at the cost of bank profitability. To

some extent, this argument has been weakened by the increase in interest on government

securities to 13.5 per cent.

MINIMUM CAPITAL ADEQUACY RATIO

The growing concern of commercial banks regarding international competitiveness and

capital ratios led to the Basle Capital Accord 1988. The accord sets down the agreement

to apply common minimum capital standards to their banking industries, to be achieved

by year-end 1992.

Based on the Basle norms, the RBI also issued similar capital adequacy norms for the

Indian banks.

CAR is the ratio that measures a bank’s capacity to meet time liabilities and risks like

operational risks, credit risks and other risks. This is done because the depositors are

secured about their deposits and banks have a cushion for their potential losses.

It is the measure of a bank’s financial strength expressed by the ratio of its capital (net

worth and subordinated debt) to its risk-weighted credit exposure (loans). It is also called

CRAR-Capital to Risk-weighted Assets Ratio.

The Reserve Bank of India (RBI), currently prescribes a minimum capital of 9% of risk-

weighted assets, which is higher than the internationally prescribed percentage of 8%.

The rates for New Private Sector Banks are 10 % ;Banks undertaking Insurance business

10 % ;Local Area Banks 15%

Most banks in India have a capital adequacy of more than 12 %. A bank with a higher

capital adequacy is considered safer because if its loans go bad, it can make up for it from

its net worth.