RBI chief vs former SBI Chief

It is former chief of SBI vs Governor of RBI. Look at these two articles:

• Former SBI Chief Criticises Rajan for Not Cutting CRR (Link: http://profit.ndtv.com/news/economy/article-former-sbi-chief-criticises-rajan-for-not-cutting-crr-752874)

• Banks Not Lowering EMIs is 'Nonsense', Says Raghuram Rajan (http://profit.ndtv.com/news/economy/article-banks-not-lowering-emis-is-nonsense-says-raghuram-rajan-752845?utm_source=taboola)

Former SBI chief says CRR cut would have allowed banks to reduce interest rate but RBI Governor disagrees. Who is right? While I am no expert on this subject, here is my attempt to understand the situation objectively. Let us understand CRR first.

Purpose of CRR

Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits (currently set at 4%) of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. It is idle money which cannot be lent, so Banks do not earn any interest on it. But it comes at a cost as banks have the obligation to pay interest to depositors on the whole of deposits. Banks do not like this and have been asking RBI to scrap CRR or reduce it. It has come down from a high of 15% during 1990’s to 4% now. But RBI will not scrap CRR as it does serve an important purpose. RBI wants to ensure that Banks do not run out of money when depositors want to liquidate their deposits. CRR along with SLR (at 21.5%) acts as a cushion of safety. When NPA’s are rising which will take out the money from banking system, Banks can still meet their payment obligations to depositors using this buffer. That makes faith in banking system remain intact in troubled times but the absence of it can threaten smoother operations. That is the interest of RBI. But Banks want to maximize their profits.

Credit growth and NPA

Let us look at how banks have managed credit growth and NPA. 

The first chart shows overall trend in credit growth is down but it is important to note that it is SBI and nationalized banks experiencing slower growth while private sector banks are not experiencing such a severe slowdown.

Credit growth in % (Data Source: RBI site)

Similarly SBI and public sector banks have more non-performing assets than their private counterparts. The written off loans reduce the money in banking system. Now we know who managed their loans better.

An IMF report says the percentage of debt owed by loss-making firms reached 23 percent in 2013/14. (Link: http://www.niticentral.com/2015/03/16/imf-report-on-indian-corporates-wakeup-call-for-government-of-india-306869.html). 

Public sector banks have approx. 4% of net NPA (and around 6% gross NPA). If they had done proper due diligence before issuing loans and acted tough on recovering their loans, they would have fared better. But they don’t have all the control as they (public sector banks) all report to Finance ministry and obey the instructions from them. Then why criticize RBI for not cutting CRR? What else to do in idle time? RBI sits on idle money with a purpose. But banks would have made their money without bothering much about CRR.