Mumbai: Banks are set to earn close to Rs1,500 crore interest from the Reserve Bank of India in the fiscal year 2006-07, following the central bank’s decision to pay interest on the cash reserve ratio (CRR) that commercial banks keep with it.
Under the law, banks have to keep 6% of their deposit liabilities with RBI as a cash reserve. However, the minimum cash balance to be kept with RBI is 3% and banks used to earn interest over and above this. Until 24 June, commercial banks were earning a 3.5% interest on the money above the cash reserves that they maintained over the stipulated 3%.
RBI stopped paying interest on CRR from June last year following the amendment of the Reserve Bank of India Act abolishing the 3% minimum cash balance floor, as well as the provision for interest payment on the remaining CRR. However, on 9 January, while formally notifying the amendment, the Central government dropped the relevant section of the Act that deals with CRR.
On 13 February, Mint first reported the serious differences between RBI and the government on the interest payment on CRR. The government was pushing the central bank to pay interest on CRR balance as it felt consumers would benefit with banks passing on some of their interest income to their borrowers. RBI had been resisting this as it feels any interest paid on CRR reduces its effectiveness as a monetary tool. RBI raises the cash reserves to tighten monetary policy.
Referring to the “extraordinary gazette notification,” a RBI release on Friday said, “in consultation with the government it has been decided” the 3% floor for CRR will remain and banks will be paid interest on cash reserves kept with RBI.
Now RBI will pay 1% interest on minimum CRR balance that commercial banks need to keep with RBI from 17 February. It will also pay 2% interest for the period between 9 December 2006 and 16 February 2007, and 3.5% interest for the period between 24 June-8 December 2006. A back-of-the envelope calculation shows this will boost banks’income by about Rs 1500 crore in financial year 2006-07. The central bank recently extracted about Rs27,000 crore from the banking system by raising CRR by one percentage point in four stages between December and February.
Bankers are happy. “We were hurt. Now that interest payments on cash balances restored, it comes in as a great relief to the banking system,” says a chairman of a Mumbai-based public sector bank, who did not want to be quoted.