Final

PREPARED BY:
BAANEE LUTHRA (15636)
SHILPA BABANAGARE (15602)
SIDDHARTH DAS (15638)
TUHINA TANDON (15635)

CONTENTS
• Acknowledgement 2
• Monetary Policy Framework in India 3
• Cash Reserve Ratio 6
• Statutory Liquidity Ratio 9
• Macro analysis 12
• Impact Of CRR And SLR On The Financial Framework 13
• Impact on Stock Markets 15
• Impact on Debt Market 17
• Impact on Foreign Exchange Markets 20
• Impact on Different Industries 21
• Impact on Common Man 25
• Monetary Policy of Mexico 26
• Monetary Policy of Korea 28
• Monetary Policy of South Africa 30
• Recent Developments 31
• Conclusion 33
• Bibliography 35
• Annexure 36
Relevance of CRR & SLR in Financial Markets | 1

ACKNOWLEDGEMENT
“Expression of feelings by words makes them less significant when it

comes to statement of gratitude”
We would hereby like to take the opportunity to thank our precious

institution “College of Business Studies” for giving us a chance to enhance
our skills and enrich our knowledge by means of on this project in the
financial service sector.
We would hereby like to take the opportunity to express gratefulness

towards Mr. Kumar Bijoy, sharing his invaluable knowledge and
experience with us. We are indebted to him for providing me with this
wonderful opportunity to undertake this project.
Thanking you,
Baanee Luthra
Shilpa Babanagare
Siddharth Das
Tuhina Tandon
(BFIA – 3rd yr)

MONETARY POLICY FRAMEWORK IN INDIA
In India, the transition of economic policies in general and financial sector policies in particular,
from a control oriented regime to a liberalized but regulated regime has been reflected in changes
in the nature of monetary management. While the basic objectives of monetary policy, namely
price stability and ensuring credit flow to support growth, have remained unchanged, the
underlying operating environment for monetary policy has undergone a significant
transformation. An increasing concern is the maintenance of financial stability. The basic
emphasis of monetary policy since the initiation of reforms has been to reduce segmentation
through better linkages between various segments of the financial markets including money,
Government securities and forex markets. The key development that has enabled a more
independent monetary policy environment was the discontinuation of automatic monetization of
the Government's fiscal deficit through an agreement between the Government and the Reserve
Bank in 1997. The enactment of the Fiscal Responsibility and Budget Management (FRBM) Act,
2003 has strengthened this further. Development of the monetary policy framework has also
involved a great deal of institutional initiatives to enable efficient functioning of the money
market: development of appropriate trading, payments and settlement systems along with
technological infrastructure.
Tools of Monetary Policy
♦ Open Market Operations:
Open market operations are the most important and active tool of monetary policy that the RBI
uses. These operations consist of the RBI buying and selling previously issued government
securities.
RBI adds extra credit to the banking system when it buys Treasury securities from the dealers,
and drains credit when it sells to the dealers. As the laws of supply and demand take over in the
reserves market, the cost of funds for the remaining reserves finds its level at the federal funds
rate.
The RBI funds rate is the interest rate banks charge each other for overnight loans.

The open market operations are conducted in the following manner:
When the RBI Eases When the RBI Tightens
RBI buys government RBI sells government

securities from a firm securities to a firm that
that deals in them. deals in them.
Ð Ð
It pays by crediting the It pays by debiting the

account that the dealer’s account that the dealer’s
bank has at RBI. bank has at RBI.
Ð Ð
The bank in turn credits The bank in turn debits

the dealer’s account. the dealer’s account.
Ð Ð
The banking system has The banking system has

more funds to lend. fewer funds to lend.
Ð Ð
Downward pressure on Upward pressure on the

the RBI funds rate—the RBI funds rate.
interest rate banks
charge each other for
overnight loans.
Ð Ð
Influences other interest Other interest rates in

rates in the economy— the economy also rise as
which also go down. a result.
Ð Ð
Gives the economy a Slows the economy and

boost. curbs inflation.

Interest rates affect the level of activity in the economy. When rates are low, people find it easier
to buy cars and homes, and businesses are more inclined to invest in new machinery and
buildings. And when the rates are high the opposite occurs as the Fed tries to curtail inflation
and maintain economic growth.
Open market operations typically are conducted several times a week. A majority of the open
market operations are not intended to carry out changes in monetary policy. Rather, they are
conducted to prevent some technical, temporary forces from pushing money and credit
conditions in some undesired direction.
♦ Reserve Requirements:
Reserve requirements are the percentages of certain types of deposits that banks must keep on
hand in their own vaults or on deposit at Reserve Bank of India. RBI has the authority to set
reserve requirements on checking accounts and certain types of savings accounts.
Reserve requirement Impact on bank lending

Raised Reduce lending
Lowered Increase lending

CASH RESERVE RATIO
Definition
The portion (expressed as a percent) of depositors' balances banks must have on hand as cash.
This is a requirement determined by the country's central bank, which in the U.S. is the Federal
Reserve. The reserve ratio affects the money supply in a country. This is also referred to as the
"cash reserve ratio" (CRR).
For example, if the reserve ratio in the U.S. is determined by the Fed to be 11per cent, this means
all banks must have 11per cent of their depositers' money on reserve in the bank. So, if a bank
has deposits of $1 billion, it is required to have $110 million on reserve.
Maintenance of CRR
In terms of Section 42(1) of the RBI Act 1934, Scheduled Commercial Banks are required to
maintain with RBI an average cash balance, the amount of which shall not be less than three per
cent of the total of the Net Demand and Time Liabilities (NDTL) in India, on a fortnightly basis
and RBI is empowered to increase the said rate of CRR to such higher rate not exceeding twenty
percent of the Net Demand and Time Liabilities (NDTL) under the RBI Act, 1934. At present,
effective from the fortnight beginning October 02, 2004, the rate of CRR is 5 per cent of the
NDTL.
Maintenance of incremental CRR
In terms of Section 42(1A) of RBI Act, 1934, the Scheduled Commercial Banks are required to
maintain, in addition to the balances prescribed under Section 42(1) of the Act, an additional
average daily balance, the amount of which shall not be less than the rate specified by the RBI in
the notification published in the Gazette of India, such additional balance being calculated with
reference to the excess of the total of the NDTL of the bank as shown in the return referred to in
section 42(2) of the RBI Act, 1934 over the total of its NDTL at the close of the business on the
date specified in the notification.
At present no incremental CRR is required to be maintained by the Scheduled Commercial

Banks.
Liabilities not to be included for DTL/NDTL computation
The under-noted liabilities will not form part of liabilities for the purpose of CRR:
a. Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount
availed of as refinance from the RBI, and apex financial institutions like Exim Bank, NABARD,
NHB, SIDBI etc.
b. Amount of provision for income tax in excess of the actual/ estimated liabilities.

c. Amount received from DICGC towards claims and held by banks pending adjustments
thereof.
d. Amount received from ECGC by invoking the guarantee.
e. Amount received from insurance company on ad-hoc settlement of claims pending Judgment
of the Court.
f. Amount received from the Court Receiver.
g. The liabilities arising on account of utilization of limits under Banker's Acceptance Facility
(BAF)
h. Inter bank term deposits/term borrowing liabilities of original maturity of 15 days and above
and up to one year with effect from fortnight beginning August 11, 2001.
Procedure for calculation of CRR
In order to improve the cash management by banks, as a measure of simplification, a lag of one
fortnight in the maintenance of stipulated CRR by banks has been introduced with effect from
the fortnight beginning 6th November, 1999. Thus, all Scheduled Commercial Banks are
required to maintain the prescribed Cash Reserve Ratio (which is currently @ 5 per cent with
effect from the fortnight beginning October 02, 2004) based on their NDTL as on the last Friday
of the second preceding fortnight.
Maintenance of CRR on daily basis
With a view to providing flexibility to banks in choosing an optimum strategy of holding

reserves depending upon their intra period cash flows, all Scheduled Commercial Banks, are
required to maintain minimum CRR balances upto 70 per cent of the total CRR requirement on
all days of the fortnight with effect from the fortnight beginning December 28, 2002. If any
Scheduled Commercial Bank fails to observe the minimum level of CRR on any day/s during the
relevant fortnight, the bank will not be paid interest to the extent of one fourteenth of the eligible
amount of interest, even if there is no shortfall in the CRR on average basis.
Payment of interest on eligible cash balances maintained by SCBs with RBI under CRR
i. All Scheduled Commercial Banks are paid interest on all eligible cash balances maintained
with RBI under proviso to Section 42 (1) and Section 42 (1A) of the RBI Act, 1934. At present,
banks are being paid interest at 3.50 per cent per annum (with effect from September 18, 2004)
ii. The Scheduled Commercial Banks were paid 100 per cent interest on CRR balances on receipt
of the quarterly interest claim statements in a prescribed proforma.
From the month of April 2003 onwards, Scheduled Commercial Banks were paid interest on
CRR balances on monthly basis on receipt of interest claim statements. With effect from August

2004, interest on CRR balances is being paid without obtaining interest claim statements from
Scheduled Commercial Banks.
iii. The amount of interest payable at the prescribed rate (presently 3.50per cent) is to be worked
out on the eligible portion of CRR balances for a period of 14 days. In case the CRR balances
held with RBI is less than the amount required to be maintained for any of the fortnights, eligible
interest will be paid for that defaulted fortnight only after working out cost of shortfall at the rate
of 25 per cent per annum and subtracting the amount so worked out from interest payable
amount.
Penalties
Shortfall, if any, observed in the maintenance of the CRR is reckoned against the eligible cash
balances required to be maintained on the NDTL. The total amount of interest payable so arrived
at is being reduced by an amount calculated at the rate of 25 per cent per annum on the amount
of shortfall. In a situation where shortfall exceeds the level at which no interest becomes payable
on eligible balances held by a bank on net basis i.e. (after interest deduction on the amount of
CRR shortfall) the penal interest as envisaged in sub-section (3) of Section 42 of the RBI Act,
1934 is made applicable.
The Scheduled Commercial Banks are required to furnish the particulars, such as date, amount,
percentage, reason for default in maintenance of requisite CRR and also action taken to avoid
recurrence of such default.
CRR (1962‐2007)
16
14
12
10
8
6
4
2
0
62
76
82
85
88
92
95
98
01
19
19
19
19
19
19
19
19
20

STATUTARY LIQUIDITY RATIO
Definition
SLR is that amount which a bank has to maintain in the form of cash, gold or approved
securities. The quantum is specified as some percentage of the total demand and time liabilities
of a bank. This percentage is fixed by RBI. The date which is taken to calculate the demand and
time liabilities of the bank is the last Friday of the preceding fortnight.
Maintenance of SLR
Scheduled Commercial Banks, are required to maintain under Section 42 of the RBI Act, 1934,
are required to maintain in India,
a) In cash, or
b) In gold valued at a price not exceeding the current market price, or
c) In unencumbered approved securities valued at a price as specified by the RBI from time to
time.
An amount of which shall not, at the close of the business on any day, be less than 25 per cent or
such other percentage not exceeding 40 per cent as the RBI may from time to time, by
notification in gazette of India, specify, of the total of its demand and time liabilities in India as
on the last Friday of the second preceding fortnight,
At present, all Scheduled Commercial Banks are required to maintain a uniform SLR of 25 per
cent of the total of their demand and time liabilities in India as on the last Friday of the second
preceding fortnight which is stipulated under section 24 of the B.R. Act, 1949.
Procedure for computation of demand and time liabilities for SLR
The procedure to compute total net demand and time liabilities for the purpose of SLR under
Section 24 (2) (B) of B.R. Act 1949 is similar to the procedure followed for CRR purpose.
However, it is clarified that Scheduled Commercial Banks are required to include inter-bank
term deposits / term borrowing liabilities of original maturities of 15 days and above and up to
one year in 'Liabilities to the Banking System'. Similarly banks should include their inter-bank
assets of term deposits and term lending of original maturity of 15 days and above and up to one
year in 'Assets with the Banking System' for the purpose of maintenance of SLR. However, both
the above liabilities and assets are not to be included in liabilities/assets to the banking system
for computation of DTL/NDTL for the purpose of CRR.
Valuation of approved securities for SLR
The entire investment portfolio of the banks (including SLR Securities) will be classified under
three categories viz.' Held to Maturity', 'Available for sale' and 'Held for Trading'. Investment

classified under Held to Maturity category need not be marked to market and will be carried at
acquisition cost unless it is more than the face value. In such a case, the premium should be
amortized over a period remaining to maturity. Individual scrip’s in the Available for Sale
category will be marked to market at the year-end or at more frequent intervals. The net
depreciation under each classification should be recognized and fully provided for and any
appreciation should be ignored. The book value of the individual securities would not undergo
any change after the revaluation.
The individual scrip’s in the Held for Trading category will be revalued at monthly or at more
frequent intervals and net appreciation/depreciation under each classification will be recognized
in income account. The book value of the individual scrip will be changed with revaluation.
Penalties
If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to
RBI in respect of that default, the penal interest for that day at the rate of 3 per cent per annum
above the bank rate on the shortfall and if the default continues on the next succeeding working
day, the penal interest may be increased to a rate of 5 percent per annum above the Bank Rate for
the concerned days of default on the shortfall.
45
40
35
30
25
20
15
10
5
0
64
72
78
84
87
90
93
97
19
19
19
19
19
19
19
19

DEPOSITS (9%) 100
Less: Cash Reserve Ratio (7.50%) (7.50)
92.5
Less: Statutory Liquidity Ratio (25%) (23.125)
69.375
Less: Day to day liquidity required 4.375
65.00
Less: Loans (18.46%) 65.00
0.00
To earn interest equivalent to pay on deposits and to meet operating expenses, banks tend
to charge a heavy interest rate on loans.
REASONS CAUSING A CHANGE IN RESERVE REQUIREMENTS
Factors leading to a rise in reserve requirements
¾ Expansion of money supply.

¾ Expansion in residency based new monetary aggregate which does not directly reckon
non resident foreign currency deposits.
¾ Growth in liquidity.
¾ Acceleration in inflation causing an increase in prices of both inputs and outputs.
¾ Enhanced capital inflows.
¾ Strengthening of rupee vis-à-vis dollar.
Factors leading to a cut in reserve requirements
¾ Lower currency expansion.

¾ Slower time deposit growth.
¾ Fall in money supply.
¾ Timely sterilization of capital inflows through open market operations and repo
transactions.
¾ Poor performance of small and medium industry and consumer durable goods as they are
being hit the most by monetary tightening.
¾ Slow growth of the economy.

MACRO ANALYSIS
Continuing the high growth phase that started in 2003-04, the Indian economy exhibited robust
growth during 2006-07. Real GDP growth accelerated to 9.4 per cent in 2006-07 from 9.0 per
cent achieved in the previous year on the back of a further firming up of activity in the industrial
and the services sectors. Both these sectors recorded double-digit growth, which more than offset
the deceleration in the agricultural sector. The services sector continued to be the mainstay of the
economy, contributing 71.5 per cent to overall growth. The sustained resurgence in industrial
activity in the recent period has reinforced the growth process, and has imparted stability to the
growth process.
Real GDP growth averaged 8.6 per cent during the four-year period 2003-04 to 2006-07 and 7.6
per cent during the 10th Plan period (2002-03 to 2006-07), significantly higher than that of 5.7
per cent during the 1980s and 1990s. The actual growth during the 10th Plan period was quite
close to the target of 8.0 per cent. Amongst major sectors, growth of the industrial sector
averaged 8.0 per cent during 2002-03 to 2006-07.
Growth in monetary and liquidity aggregates accelerated during 2006-07, with broad money
growth remaining above the indicative trajectory projected by the Reserve Bank at the beginning
of the financial year. Broad money (M3) growth, accelerated to 21.3 per cent at end- March 2007
from 17.0 per cent a year ago and remained above the growth rate of 15.0 per cent projected in
the Annual Policy Statement in April 2006.
Global headline inflation remained firm during 2006-07 reflecting the combined impact of
higher international crude oil prices in an environment of strong demand and closing of output
gaps. Although inflation moderated somewhat with the easing of crude oil prices from August
2006, inflationary pressures continued from other commodity prices and increased capacity
utilization rates. As a result, headline inflation remained above the inflation targets/comfort
zones in major economies. Headline inflation in India, based on movement in the wholesale price
index (WPI), rose to 5.9 per cent as on March 31, 2007.
In 2006-07, the private corporate sector sales grew by 26.2 per cent and net profits grew by 42.2
per cent, both higher than the levels a year ago.
The RBI therefore had a dual task of not detailing the growth any further and at the same time
keeping the liquidity situation under control to maintain WPI inflation around 5 per cent for
2007-08. To balance these objectives in its first quarter review, the RBI increased the CRR by 50
basis points to 7 per cent while keeping repo and reverse repo rates unchanged at 7.75 per cent
and 6 per cent respectively.

IMPACT OF CRR AND SLR ON THE FINANCIAL FRAMEWORK
♦ Liquidity and Interest Rates
A CRR cut increases the money multiplier since it leaves a larger fraction of deposits free to be
disbursed as credit. This helps to improve the liquidity within the banking system without
affecting its monetary base.The CRR cut, could put pressure on banks to find ways and means of
deployment of funds.
CRR hike is used as an important weapon to mop up liquidity. With a rise in CRR the liquidity in
the rupee market will go down forcing banks to sell dollars to generate rupee funds. This would
drive up rupee in the short term.
During the first quarter, while the 1-year yield declined from 7.55 per cent at end-March 2007 to
6.84 per cent by July 27, the 10-year yield moderated from 7.97 to 7,89 per cent. The RBI
according to its mandate seeks to attain the objectives of ‘promoting price stability and ensuring
adequate bank credit to productive sectors’. To maintain the value of currency the RBI therefore
intervenes heavily in foreign exchange markets during times of high capital inflows, which
results in a build up of foreign exchange reserves.
♦ Inflation
Inflation is actively back as a policy concern now, after Wholesale Price index (WPI) figure of 6
per cent plus, the highest in two years-— a rate higher than the 5-5.5% inflation rate that the RBI
has indicated as acceptable. Inflation has been an RBI concern for some time.
Since oil prices are based on global factors and commodity prices of primary articles get affected
by short term factors and are often highly volatile, many countries look at “core inflation.” Core
inflation basically means excluding the prices of these two highly volatile components from the
inflation figures. Even if that’s done, inflation based on prices of manufactured goods, a measure
of core inflation, rose by 5.9%.
Analysts opine that Indian economy, is overheating- high growth rate and rising inflation rate,
high real-estate prices and rising salaries. The concern is how to pacify this overheating, if there
is any. A high interest rate and constraints on liquidity will control the inflation but at the same
time will bring down the growth. Despite of being blamed for spoiling the party, RBI has taken a
strong step to tighten monetary policy. It has announced a hike of 0.5 percentage points in cash
reserve ratio.
A CRR hike means banks will have to hold more cash, rather than pumping it into the economy.
The effect of a hike in CRR is to cut the overall amount of money in the system. Since the supply
of money is decreased, it’s purchasing value increases. So this should reduce inflation.
Sometime back, banks could sell the government securities, and hence meet the lending
demands. Now that the stock of government securities with banks has declined to the SLR
(Statutory Liquidity Ratio) levels of 25 percent, any increase in lending will have to come about

only when banks borrow more. The impact of small changes in interest rates will be much higher
than it has been.
A CRR cut would pump in liquidity in the markets thereby increasing the money supply in the
economy. Enhanced money supply would lead to a rise in input and output prices, thus raising
the level of inflation. A continued rise in inflation tends to slow down the growth of the
economy.
♦ Exchange Rate
Increasing interest rates tends to increase the foreign capital investment. India is in a transition
stage, wherein it’s progressively becoming an open economy from a closed one. The
complexities thus increase, because of the linkages between exchange rate movements and
interest rates and the impact of increasing capital flows across the border.
The CRR hike and changes to the reverse repo mechanism are not expected to have a direct
impact on the exchange rate in the near term.
A cut in reserve requirements would raise the level of liquidity in the system. This will lead to a
decrease in inflow of foreign money that is coming into India for interest rate arbitrage and thus
would stem the rupee rise higher.
Thus we can say that
A hike in CRR decline in liquidity higher interest rates Rupee depreciates
A 0.50% hike will drain out Rs 150 billion (Rs 15,000 crores) from the economy. It sends a
strong signal that the RBI is clearly focused on taming inflation, which in recent months has
risen dramatically. While in the near term this will have an adverse impact on overall economic
growth, from a long term perspective, it will be beneficial for the economy.
A cut in CRR Rise in liquidity fall in interest rates Rupee appreciates
The 50 basis point cut in CRR will provide the necessary liquidity of Rs 6000 crores to the
money market, which has otherwise been witnessing a short-term hardening of interest rates. The
liquidity so created through RBI intervention would stem rupee rise higher.

IMPACT ON STOCK MARKETS
A hike in CRR leading to rising interest rates have several implications including -
¾ Slowing down the overall growth in the economy; this effectively means that demand for
goods and services, and investment activity, gets adversely impacted
¾ Apart from the fact that overall growth is impacted, companies take a hit on account of
higher interest costs that they have to bear on their outstanding loans (to the extent their cost
of funds is not locked in)
¾ Since some investors tend to leverage and invest in the stock markets, higher interest rates
increase expectation of returns from the stock markets; this has the impact of lowering
current stock prices.
¾ An overall decline in stock prices has a cascading effect as leveraged positions are unwound
(on account of meeting margin requirements), leading to still lower stock prices
So, from a short term perspective, higher interest rates should adversely impact stock market
sentiment.
From a long term perspective however our expectations of returns from the stock markets
remains unchanged. As mentioned earlier, RBI's move to tame inflation over the long term
augurs well for long term economic growth (there is more predictability and therefore risk
premiums are lower). This will ultimately benefit well-managed companies.
It's difficult to say how the stock markets will react; or for that matter to what extent the markets
will react. In the last few trading sessions, there has already been a correction of about 4% in the
BSE Sensex.
It is impossible to predict near term movement in stock prices. And therefore any investment you
consider should be made keeping in mind that in the near term you could be sitting on losses on
fresh investments. From a 5 year perspective however we are reasonably confident that a well
managed equity fund can deliver returns in the range of 12% - 15% pa. This is not to say that you
will make this return every year. There will be years in which you may lose money, and others
where you may make far more than what we have projected. Over the 5 year tenure, on a point to
point basis, you will average a return of 12% - 15% pa, which in our view is a realistic estimate.
CRR hike has the potential to significantly dent equity markets. The risk involved in such a
stance is that the RBI is likely to end the growth party in India. The RBI move might result in
lower PE for the market. That being the case, this is not yet the peak for markets overall, but
certain sectors will have to struggle; PSU banks, real estate and autos will see a fall.
In Indian equity markets there are three levels of macro risk; a high P/E, a relatively overvalued
rupee and interest rates that have stayed relatively low considering the level of economic growth,
and we associate these things with growth. The P/E multiples are high because growth is strong,

the rupee has been firm because strong growth has attracted capital and that capital has helped
keep interest rates low. With CRR hike RBI is about to end the growth party and if growth
begins to slow down then you are likely to see a lower P/E, a low rupee and a potentially higher
interest rates.
A cut in CRR would lead to a fall in interest rate. A cut in interest rates would make savings in
banks unattractive. Thus, depositors may move to the stock market at a time when the revival of
the bourses is crucial for regenerating Indian industry. Thus a reduction in CRR would boost the
securities prices and players are also expecting the Government to align the savings rate to the
same structural levels.

IMPACT ON DEBT MARKET
An increase in the CRR indicates a liquidity crunch with the bank and to compensate for the
crunch it hikes interest rates.
Therefore, an increase in the CRR and the repo rate create paucity of liquidity in the debt market.
One of the fallouts of such a move is that the yield of a bond increases as the bond's price
decreases (Banks sells bonds to create liquidity). This helps judicious investors.
Thus increase in CRR:
• Increase in bond yields

• Fall in interest rates on deposits
• Rise in interbank call rate
• Rise in interests rates on loans
However, existing investors in debt oriented funds may take a one time hit; but at the same time,
since overall interest rates are higher, from here on, such funds will yield higher returns.
Although the interest rates have risen quite a bit, it may still not be the best time to lock in all
your money in long term debt instruments.
Short term Fixed Maturity Plans (FMPs), which can yield an annualized return of about 8% on a
post tax basis for a three month deposit or well managed Monthly Income Plans (MIPs) offered
by mutual funds are attractive in view of rising interest rates. The low risk option (equity less
than 20% of assets) with a quarterly dividend option can also be exercised. With higher interest
rates and possibly lower stock prices, MIPs could yield an attractive post tax return.
With CRR hike the interest rates rise and if one looks at three-month commercial paper rates,
you have gone from around 7 to 9.5, so the market is already tightening.
♦ A rise in Cash Reserve Ratio leads to a rise in market rates both of the deposit and the
lending rates. In Collateralized borrowing market, rates rose to 9.7% for the day, after
opening at 6.9%. The rates ended the day 7.75% after transactions worth Rs 28,546 crore
were carried out.
♦ Impact on bond yields: A hike in CRR aimed at controlling inflationary pressures. Thus
bonds are expected to experience some elevation due to CRR and Repo rate hikes.
♦ Rise in lending rates: Buying a home or a car or seeking a personal loan for an overseas trip
may pinch a lot more with the rise in cash reserve ratio as most bankers feel that it is
imperative that lending rates will shoot up further, at least, by another 25-50 bps.
♦ Impact on government securities: The rise in G-sec yields was limited as compared to the
other segment of the bond market. This was mainly on account of the continued incremental
Statutory Liquidity Ratio (SLR) requirement of the banks and buying by other large
institutional investors. The government securities market started the month on a positive

note with the yield on ten-year bond falling to 7.38% levels against the previous month close
of 7.43%. The hike of Cash Reserve Ratio (CRR) leads to a sharp rise in yield on ten-year
G-sec. A CRR hike has a negative impact on Liquidity Adjustment Facility (LAF). It tends
to tighten the LAF causing LAF balances to fall.
The government securities market remained volatile for most part of the month after CRR
hike. The market saw good buying at these levels due to the investment demand and lower
than expected inflation numbers. The ten-year yield gradually softened to the levels of 7.59%
before closing the month at 7.62%. The liquidity remained strained for most part of the
month. The impact of CRR hike was seen immediately after the announcement.
♦ The overnight call rates which remained in the range of 6.00-6.10% in the first week
gradually moved up to 11.00-11.50% by month end, touching a high of 19% levels. The
tightening of liquidity condition was evident in the Liquidity adjustment facility (LAF)
figures of RBI. The rupee liquidity dwindled for the remaining part of the month mainly on
account of advance tax outflows and the CRR hike.
♦ Impact on the inter-bank call market: the inter-bank call market rate is expected to rise
following the 50-basis point hike in CRR which has mopped up Rs 16,000 crore from the
system. The rates went up to 9.75% for the day, after opening at 7.5%.
Cut in reserve requirements:
♦ A cut in reserve requirements leads to a fall in PLR. A cut in CRR would have impact on
interest rates on commercial papers, FCNR etc as their interest rates are PLR linked.

♦ Impact on bonds: If RBI decides to lower reserve requirements, this will cause banks to
have an increase in the amount of money they can invest. This causes the price of
investments such as bonds to rise, so interest rates must fall.
♦ Impact on govt securities: In the monetary and credit policy for 2002-2003, the RBI had
announced that the CRR be reduced by 50 basis points from the fortnight beginning June 15,
2002. This cut is aimed at easing off the market tightness. The G-sec market that has been in
a slump, post credit policy, with bond prices crashing by Rs 2-3 across maturities triggered
by massive sell offs. A CRR cut is aimed to avoid interest hardening situation. The rate cut
will help banks show improved profitability for the year ended March 31, 2001. This is
because the rate cut will raise the prices of gilts and the valuation of the gilts held by the
banks will go up.
A cut in SLR would lead to a:
The short-term sentiment impact, which is already seen with yields on the 10-year g-sec
shooting up by 20bps on January’ 12 over a day; and a long-term structural impact which
will affect the demand-supply equation of bonds.
♦ Fall in interest rates: A CRR cut is aimed to increase banks' capacity to lend, which will
position the economy when a rebound encourages borrowers to borrow. This would also have
an across the board positive impact on appreciation in State Government securities, approved
securities and corporate bonds.

IMPACT ON FOREIGN EXCHANGE MARKETS
Rise in reserve requirements:
When RBI decides to raise the reserve requirements the amount of money available with banks
for investment falls short. This causes an increase in supply of bonds and reduction of bond
price. Thus, causing a rise in the rate of interest. Higher interest rates cause the cost of financing
capital projects to be higher, so capital investment will be reduced.
A rise in CRR raises the demand for domestic currency rises and the demand for foreign
currency falls, causing an increase in the exchange rate i.e. the value of the domestic currency is
now higher relative to foreign currencies. A higher exchange rate causes exports to decrease,
imports to increase and the balance of trade to decrease.
The rupee went through a volatile day before ending slightly weaker against the dollar. The local
currency ended at 39.36/37 against the dollar, slipping from its previous close of 39.32/33 level.
Cut in reserve requirements:
If RBI decides to lower reserve requirements, this will cause banks to have an increase in the
amount of money they can invest. This causes the price of investments such as bonds to rise, so
interest rates must fall. When interest rates are lower, the cost of financing capital projects is
less. So all else being equal, lower interest rates lead to higher rates of investment.
A cut in CRR lowers the demand for domestic currency and the demand for foreign currency
rises, thus causing a decrease in the exchange rate i.e. the value of domestic currency falls in
relation to foreign currency. A lower exchange rate causes exports to increase, imports to
decrease and the balance of trade to increase.
Since bond prices rise, an investor will sell his domestic bond, exchange rupees for foreign
currency, and buy a foreign bond. This causes the supply of rupees on foreign exchange markets
to increase and the supply of foreign currency on foreign exchange markets to decrease. This
causes the domestic currency to become less valuable relative to the foreign currency. The lower
exchange rate makes domestic produced goods cheaper and foreign produced goods more
expensive in foreign country, so exports will increase and imports will decrease causing the
balance of trade to increase.

IMPACT ON DIFFERENT INDUSTRIES
¾ Impact on Banking Industry
♦ Net interest margins:

As a result of the recent CRR hike the net interest margins come under pressure because of the
incremental deposits being raised at a fairly high cost. If this trend continues then the NIMs will
come under pressure or they will have to increase the lending rates, we expect the liquidity to
remain fairly tight and that is probably one of the reasons why the Ministry of Finance has
authorized RBI to cut SLR to fund the credit growth. So somewhere the banking sectors will be a
little bit under pressure because of the rising deposit growths not equally matching rise in the
credit side and hence some pressure on the net interest margin.
♦ Interest rate hike:

A hike in CRR would suck out liquidity from the system. Moreover RBI has reduced its interest
outgo towards banks (as interest on CRR maintained) from 6 per cent to 3.5 per cent. Earlier,
banks would park in idle cash at the repo auctions. However, with the rise in CRR, the idle cash
is likely to reduce, thereby eating into the treasury returns. However, a hike in interest rates is not
ruled out after this move. But for competition, the country would surely witness a rate hike.
The cut in the bank rate is a signal for reducing lending rates. However the impact may be
limited due to the following reasons:
(a) A floor of 4 per cent on the savings deposits reducing the flexibility for cutting prime lending
rates (PLR);
(b) Competition from the Government’s small saving schemes with administered interest rates
leave little room for bank deposit rates to come down;
(c) High intermediation costs of banks, which are mainly influenced by their operating costs (2.5
to 3 per cent of the total assets for PSBs at present), keeping spreads and therefore lending and
deposit rates sticky; and
(d) High cost of fund mobilization, with an average of cost 7 per cent for PSBs, the largest
mobilizers of deposits.
This would at best give the banks room for cutting their PLR’s marginally by 10 to 15 bp, the
margin by which the reserve adjusted cost of funds would go down. Any cut in the lending rates
is going to put pressure on the profitability of the banks as it would impact their margins.
♦ Taming Inflation:
Inflation tends to have a negative impact on the earnings and performance of banks. Banking
sector experienced a fall in earnings in the year 2004-05 ranging from 2.6% to 45%.

Other income (Rs m) 1QFY04 1QFY05 (%) Change
SBI 17,529 15,387 -12.2%
Oriental Bank 1,817 998 -45.1%
Corporation Bank 1,257 1,001 -20.4%
HDFC Bank 1,322 1,080 -18.3%
IDBI Bank 428 417 -2.6%
UTI Bank 1,503 1,101 -26.7%
A rise in CRR would help in controlling the inflationary pressures and improving the
profitability of banks. With a cut in reserve requirement rate, the value of investment portfolio of
banks would rise. This would have positive impact on the profits of banks and EPS."
♦ Impact on domestic deposits
Impact of cut in reserve requirements

The likely impact of the bank rate and CRR cut on deposits via deposit rate changes is also going
to be marginal. In absence of variable rate term deposits, banks have little room to cut deposit
rates, as it can lead to money flowing in to mutual funds or small saving schemes. Besides the
scope for a cut is limited by the impact on lending rates i.e. a cut by 10 to 15 bp.
Impact of rise in reserve requirements

The move will benefit the fixed deposit investors as banks are likely to raise the interest rates on
term money. But the flip side is that consumer loans and housing loans will now become costlier.
♦ Impact on foreign deposits
Foreign currency deposits were earlier exempt in calculation of CRR, but will now be counted
for the same. This means that banks with relatively bigger corpus of foreign deposits, in
proportion to domestic deposits, would need to put away more funds toward CRR and hence cost
of funds from such deposits would go up. This would require banks to rationalize interest rates
on foreign deposits, which traditionally had more aggressive interest rates. Smaller foreign banks
which have borrowed heavily from their parent banks will be hit harder. Among all bank groups,
foreign banks, witnessed the largest reduction in their intermediation costs (difference in interest
income and expenditure) by 38 bp in FY00. The repeal of CRR exemptions can alter this
scenario.
♦ Gain from CRR cut
All scheduled commercial banks (excluding regional rural banks) will be paid interest on eligible
cash balances maintained with RBI under the CRR requirement at the rate of 3%. These balances
have generally been viewed as nonperforming assets as average interest earned on such balances
is around 2.7 per cent as against 8 to 9 per cent which can be earned by investing in the

government securities or even higher return which can be earned in times of high demand for
credit.
¾ Impact on Capital goods industry:
The last three years' soft interest rate regime had a positive impact on India Inc as the industry
witnessed lower interest outgo and also cost cutting, which made the Indian markets attractive in
the global arena. As a result of low interest rates, companies undertook large capital-intensive
projects. However, with an upward shift in interest rates, it is likely that major projects with a
positive internal rate of return turn negative as cost of financing goes up. This move would hit
the long-term profitability of the industry as major corporates would either postpone or cancel
orders.
¾ Impact on Auto industry:
Retail loans form a major part of a bank's loan portfolio. To put things in perspective, more than
80% of vehicle sales are financed by the banking industry. A hike in interest rates is likely to
affect this price sensitive segment. Further, material cost increase on account of rising working
capital costs would have negative impact on margins. Also, the plans to project the country as a
manufacturing hub would take a hit in the face of rising interest rates where financing activities
would become costlier. Further, with intense competition, aggressive pricing is the order of the
day.
¾ Impact on Infrastructure:
Rise in reserve requirements
The country's budget has laid special emphasis on infrastructure activities with over Rs 400 bn
being earmarked for the same. Large construction activities coupled with agricultural projects

(irrigation) shall result in high costs. A hike in interest rates would result in postponement of
these plans. This is likely to impact companies catering to the infrastructure segment such as
steel, cement and energy. Power projects, which are capital intensive, are likely to be worst hit in
the face of rising interest rates as usually; high gestation periods in the segment attract relatively
higher costs.
Cut in reserve requirements
Impact of a CRR cut on industry would mainly depend on how banks react to them. In the past,
banks had reduced the deposit rates in response to bank rate and CRR cuts, the same has not
happened for lending rates of banks. The demand for funds from industry would, however,
depend a lot on how growth takes place and the extent to which new investment is undertaken.
The policy focus today is given on infrastructure. RBI has sought to relax certain regulatory and
prudential aspects for such finance so as to allow banks to increase their credit to this sector. To
begin with the scope of the definition covering infrastructure is to be widened. Raising the
single-borrower prudential limit from 15 to 20 per cent of capital funds will help banks to focus
more on this sector. Further, by assigning a concessional risk weight of 50 per cent on
investment in securitised paper satisfying conditions pertaining to infrastructure activity, we can
expect a flurry of activity in this segment. On the whole, the policy can be seen as having
positive impulses on the economy as well as industry and infrastructure.

IMPACT ON THE COMMON MAN
Hike in reserve requirements
¾ Higher returns from debt oriented instruments due to high interest rates.
¾ Loans would become costly as the banks would charge a higher rate of interest. As long
as the rate of interest on the loan is fixed, the borrower would be immune to any rise in
interest rates. However, if he has a floating rate loan, then either the tenure of the loan or
the EMI would increase.
The WPI, which is an index of wholesale prices, takes some time to show up in CPI numbers.
Thus, we can expect a salubrious movement in CPI to follow the downturn of the WPI by a few
months.
Further the CPI places a much greater emphasis on food (46% weight in CPI as opposed to 15%
in WPI). Therefore the CPI tends to be less interest rate sensitive and more affected by supply
side movements than the WPI. In other words, the problem of inflation has partly already been
solved (since WPI is down and CPI follows WPI with a lag), and the portion remaining cannot
be solved through monetary tightening since the CPI is affected by non-monetary measures far
more than by monetary measures.

MONETARY POLICY OF MEXICO
Mexico follows a zero-average reserve requirement system. The system works within 28-
calendar-day maintenance periods in which each bank strives to manage the balances on its
current account at the central bank so that, at the end of each period, its daily balances sum to
zero. The incentive for doing so lies in the fact that if the accumulated balance is negative, the
bank in question would have to pay high interest rates on it, whereas if it is positive, the bank
forgoes any return it might have earned by investing the funds elsewhere. This reserve
requirement system is designed to induce credit institutions to avoid, on an average basis,
overdrafts or positive balances on their current accounts, and offset any excess or lack of
resources they might have by lending to other banks or borrowing from them at market interest
rates. It is for this reason that, during maintenance periods, the Bank of Mexico does not pay
interest on positive balances or charge interest on overdrafts posted at the end of each day, as
long as both are kept within certain pre-established limits.
The total accumulated balance may also differ from its target when the current accounts of one or
more commercial banks post positive balances or overdrafts exceeding their respective positive
or negative limits. The amounts exceeding these limits are not taken into consideration for the
computation of the accumulated balances of the banks in question, and therefore are not
considered in the total accumulated balance either.
For example, if a bank incurs a 150 million pesos overdraft while subject to a 100 million pesos
negative limit, on the following day it will have to pay a penalty equivalent to twice the CETES
rate on the 50 million pesos by which it exceeded its limit. Nonetheless, in the future the bank
will have to offset a 100 million pesos overdraft only, for the 50 million pesos excess overdraft
will not be considered in the computation of the bank’s accumulated balance or in the system’s
total accumulated balance. The latter item will then surpass the target announced by the Bank for
that day by 50 million pesos. In its intervention in the money market the following day, the
central bank will have to reduce the amount of resources provided to the market by 50 million
pesos, so as to bring the total accumulated balance to its target.
By the same token, should a bank report a 150 million pesos positive balance in its current
account while its positive limit is 100 million, the bank will have the right to overdraw, without
cost, up to 100 million pesos on its account during the days remaining to the end of the
maintenance period. The 50 million pesos in excess will not be considered in the bank’s
accumulated balance or in the system’s total accumulated balance. Therefore, the latter will be
50 million pesos below the amount announced by the central bank for that day. On the following
day, the Bank will have to increase the amount of resources provided to the market by 50 million
pesos, so as to bring the total accumulated balance to target.
The central bank of Mexico mainly relies on open market operations to correct inflationary
pressures in the economy. It as well influences changes in the CETES rates to tackle issues

related to liquidity in the economy. The yield on the one-month T-bills, known as CETES, was
expected to edge up to 7.46 percent as on 31st December’ 2007.

MONETARY POLICY OF KOREA
Measures taken to reform monetary policy instruments included the lowering of minimum
reserve requirement ratios, a sharp reduction of the aggregate ceiling on the Bank of Korea’s
discount window and the introduction of free competitive bidding for open market operations.
Lowering reserve requirement ratios
Until the early 1990s the Bank of Korea made frequent use of changes in reserve requirement
ratios for managing domestic liquidity. In particular, they were actively used during the late
1980s when the Korean economy experienced a substantial current account surplus. In an effort
to absorb the excess liquidity generated by the external sector, the average reserve ratio of 4.5 %
in 1986 was raised to 10.4% in 1990.
Lowering reserve requirements may cause the following 3 problems:
¾ An increase in the ratios places banks at a competitive disadvantage in deposit-taking vis-

à-vis non-bank financial institutions which are not subject to reserve requirements.
Korean experience was that banks’ share in deposit-taking continued to fall sharply,
largely as result of the high reserve requirements imposed on them. More specifically,
banks’ share in total deposits fell from 48.8% in 1985 to 34.9% in 1990 and to 28.1% in
1997.
¾ Secondly, since reserve requirements are enforced on the basis of a strict regulatory
framework, heavy reliance on changes in reserve requirement ratios for monetary control
gives a central bank less scope for implementing market oriented operations. This could
in turn well delay the further development of financial markets.
¾ Finally, changes in reserve requirement ratios are probably not an effective tool in
managing the liquidity of non-bank financial institutions. In particular, the effectiveness
of changes in reserve requirements may well be more limited in managing liquidity
where financial markets are more highly compartmentalized.
In view of these problems, the Bank of Korea no longer makes active use of changes in reserve
requirements in managing domestic liquidity. The decisive break came with the sharp reduction
of reserve requirement ratios undertaken in three steps between April 1996 and February 1997.
The main purpose was to improve banks’ profitability and competitiveness in deposit-taking vis-
à-vis non-bank financial institutions which had not so far been subject to reserve requirements.
The average reserve requirement ratio of 9.4 % in March 1996 was lowered to 3.1% by February
1997. Along with these measures, a 2.0 % reserve requirement was introduced on deposit-taking
through the sale of CDs upon the abolition of ceilings on their issuance in February 1997. More
recently the Monetary Board decided to raise the permissible ratio of vault cash in banks’ reserve

requirements. Specifically, banks were allowed to hold up to 35%of their reserve requirements as
vault cash from 23rd May 1998 against the previous maximum of 25%.
The Bank of Korea (BOK) recently announced a rise in deposit reserve requirement ratio for
commercial banks, effective from December 23, 2006. Specifically, the demand reserve
requirement ratio will be taken up to 7% from 5%. At the same time, the BOK cut the long-term
time deposits reserve requirement ratio to 0% from 1%.
Liquidity growth to recede: While the immediate impact on banks may not be significant, the
move by the BOK will reduce liquidity in the economy as it effectively brings the reserve
requirement above what the banks are currently holding. If not overtly negative, today’s move
undeniably caps the positives in next year’s economic outlook through reducing liquidity, which
has been a growth driver in the past two years. On top of that, added pressure comes from an
expected decline in the trade surplus, as Korea is heading into an export slowdown. Korea’s
overall liquidity conditions will be less favourable in the year ahead.

MONETARY POLICY OF SOUTH AFRICA
The Reserve Bank can create the monetary conditions to obtain a suitable growth rate in the
money supply by controlling the reserve assets that banks have to hold or by operating on the
level of interest rates. In the Reserve Bank’s previous operating procedures the Bank opted for
the so-called classical cash reserve system based on recommendations made by the Commission
of Inquiry into the Monetary System and Monetary Policy in South Africa.
A statutory minimum reserve asset requirement has been employed as a monetary policy
instrument since the establishment of the Reserve Bank in 1921. The cash reserve requirement
has generally been regarded as a useful monetary policy instrument in that it provides a source of
demand for central bank reserves in the event of large and sustained changes in domestic
liquidity. Variations in cash reserve requirements have generally not been used in the day-to-day
management of money market liquidity because they are comparatively unwieldy, take some
time to become effective and frequent adjustments could disrupt the efficient management of
banks’ portfolios.
The cash reserve requirement has changed considerably over time in South Africa. Changes were
introduced to simplify the system or to counter certain practices applied by banks to circumvent
the effects of the requirements. Although the reserve ratio was lowered over time, the amount of
cash reserves that the banks were required to hold at the Reserve Bank rose from about R2
billion in 1988 to approximately R12 billion in 1997 due to the growth in the amount of deposits
held at the banks. As a ratio of total deposits, the cash reserve holdings of South African banks
declined during the 1980s to a lower turning-point at the beginning of 1992 of about 1.50%. This
ratio then rose relatively sharply and fluctuated more or less between 21/2 and 3% from 1995 to
1997.
The reserve base of the banks for the basic requirement was total liabilities as adjusted for capital
and reserves less interbank deposits and repurchase agreements of 31 days and shorter with
government bonds and Treasury bills as security. The reserve base for the additional requirement
was restricted to only the short-term liabilities less deposits pledged as security for loans granted,
the amounts owing by banks and mutual banks, repurchase agreements of 31 days and shorter
with government bonds and Treasury bills as security, and 500/0 of remittances in transit.
The eligible assets for reserve requirements consisted of banks’ balances on current and reserve
accounts at the Reserve Bank plus their holdings of South African bank notes and coin in their
vaults, tills and automated teller machines. Vault cash was included as part of the cash reserve
requirements mainly in order to limit the financial, logistical and administrative burden on the
banks. If vault cash was not included, some banks could at the end of the day transport it back to
the Reserve Bank and redeem it for reserve deposits, thus increasing the administrative burden of
the central bank and these banks.

RECENT DEVELOPMENTS
Cut in reserve requirement (year 2002)
Monetary conditions remained stable during 2002-03. Large and persistent capital inflows were
sterilized by timely open market and repo operations. Consequently, base money expansion
remained moderate. Money supply, in terms of broad money (M3) excluding the effects of
mergers as well as the residency based new monetary aggregate (NM3), remained in alignment
with initial expectations. The revival in non-food bank credit, which was evident in the last
quarter of 2001-02, firmed up throughout 2002-03 reflecting the improvement in the industrial
climate. Nevertheless, liquidity in the financial system was ample. This was reflected in the
broader measures of liquidity (L1, L2 and L3). Despite the Centre’s market borrowing moderately
exceeding the budgeted level, there was a softening of interest rates with varying sensitivity
across the spectrum.
M3 (net of the full impact of mergers) moved in consonance with its projected trajectory of 14.0
per cent during 2002-03. Lower currency expansion relative to trend as well as slower time
deposit growth restrained the monetary expansion. On the other hand, the relative contribution of
demand deposits to aggregate deposits growth rose, indicating a shortening of time preference at
the margin. On a year-on-year basis, M3 expansion was 13.3 per cent as on April 4, 2003 as
compared with 14.0 per cent a year ago.
Market liquidity was augmented by the Reserve Bank’s primary subscription to the Central
Government’s market borrowing programme (Rs.36, 175 crore) and release of resources by way
of lowering the cash reserve ratio (CRR) (around Rs.10, 000 crore). In 2002-03 reserve
requirements was reduced by a cumulative 75 basis points reduction in the CRR to 5.75%.
Hike in reserve requirements (year 2007)
The Reserve Bank of India (RBI) unexpectedly hiked the cash reserve ratio (CRR) 50bp to 7.5%,
but—as widely expected--kept the repo (the rate at which it injects liquidity, currently at 7.75%)
and the reverse repo (the rate at which it withdraws liquidity, currently at 6%) unchanged. The
previous hike in CRR was announced in July, and the latest increase is effective November 10
and will withdraw INR160 billion. It is the fifth increase, including the first one in the current
tightening cycle in December 2006. The RBI last hiked the repo rate in March.
The central bank maintained the full year GDP growth forecast for 2007-08 (year that began
April 1) at 8.5%oya. The inflation forecast has also been left unchanged at 5%, though the RBI
has lowered the medium-term guidance to 3.0% from 4-4.5%, an outcome it sees being
"consistent with India's broader integration with the global economy".
The latest CRR hike is mainly a liquidity management tool and is not intended to give any
interest rate signal. Capital inflows will remain challenging for the RBI, and further hikes in
CRR and more restrictions on some kinds of capital inflows are likely. However, the timing of

CRR hikes remains uncertain, as it will depend on the magnitude of capital inflows and the
nature of additional measures that are announced to check capital inflows.
In the past 12 months, the RBI has raised CRR by 200 basis points to manage liquidity. There is
a growing feel in the banking system that the NIMs in the third and fourth quarter will remain
under pressure as although banking have started slashing deposit rates, banks have not yet raised
lending rates lately.
The CRR hike may help in checking the inflationary pressures. Still, there are legitimate near-
term risks to liquidity:
(1) Seasonal tightness from increases in "currency in circulation" owing to the Indian festival
season currently beginning now,
(2) Government receipts in excess of spending, especially the excise tax payments in the
second week of November and,
(3) The latest CRR hike being effective around the same time.
Investors will most likely react by unwinding received positions, leading to higher and flatter
curves; the impact will likely be more pronounced on the OIS curve and bonds will likely
outperform swaps in this environment.
However the impact of the recent CRR hike shall be limited as the additional amounts of funds to
be drained is some way below the amount recently injected through foreign reserves.

CONCLUSION
Current banking scenario:
Deposits continue to remain the mainstay of the resource mix of SCBs. As on March 31, 2007
deposits constituted over 77% of the total liabilities of all SCBs as against 81% a year ago.
In last couple of years the growth in deposits has not been able to keep pace with the high credit
growth compelling banks to liquidate some of their holdings of government securities. This has
now brought down the Statutory Liquidity Ratio in the banking system very close to the minimal
level, thereby limiting the scope of further liquidation. This invariably increased the dependence
of banks on deposits for funding future credit growth.
This mismatch between the growth in credits and deposits forced banks to shore up interest rates
at the shorter end on deposits, transforming the deposit mix in the process.
With the spread between short term and long term deposits being narrowed down, investors
preferred short term deposits and were averse to locking their deposits for long periods. The
increased preference for short term deposits could also be attributed to lower or comparable
returns on other long term maturity instruments like postal deposits, public provident funds etc.
As a result the share of short term deposits in total term deposits went down by 40%.
The slowdown of credit growth and the prevailing liquidity condition reduced the dependence of
banks on short term deposits by lowering their deposit rates. The current CRR hike might result
in further slowdown in credit demands thereby forcing banks to revisit their deposit growth
strategies. Thus banks may further reduce their short term deposit rates to manage their margins
in the reduced credit takeoff environment.
Do we need a change in reserve requirements?
Indian financial markets have experienced large swings in liquidity and heightened volatility as a
result of easing off oil prices, commodity prices etc. money markets have experienced excess
liquidity which is reflected from the call rates closing to 1% levels and sinking even further on
several occasions.
The monetary measures taken by RBI have had the intended effect. Inflation has come off its
peak and is well below the preferred level of 5%. The appreciation of the rupee over the last few
months has provided the necessary cushion in controlling inflation. However the unidirectional
movement of the rupee has affected Indian export competitiveness.
At the same time RBI had resorted to huge dollar purchases to support the currency. This had
resulted in excess liquidity in the system with M3 growing at 21.6% on a year on year basis
which was well above the projected level of 17.5%.

Given the strong outlook on capital inflows, potential upside risks to inflation from higher oil
and commodity prices and the need to maintain export competitiveness of the Indian industry,
the RBI resorted to the following measures to absorb liquidity and to mitigate inflationary
pressures:
¾ RBI has lifted the 30 billion cap on daily liquidity absorption at the 6% reverse repo
rates.
¾ Increase in CRR: It will force banks to choose between credit growth and margin.
PROS:
∗ The recent monetary tightening will be more effective in checking credit expansion as
the banks don’t have the latitude they enjoyed previously in funding loan growth via
running down their holding of government bonds.
∗ Since the productive lending is being impacted a cut in SLR ratio would accelerate the
loan growth.
CONS:
∗ Between a cut in CRR and a cut in interest rates, the RBI should choose the latter. A
cut in CRR will signal intent of boosting liquidity and prevent banks from raising rates
if they had intended to do so. However, where an actual boost to liquidity is called for,
one cannot avoid a cut in interest rates.
∗ The cut in interest rates will also lead to a decrease in the inflow of foreign money that
is currently pouring in to take advantage of the higher rates in India, and thereby
control exchange rate appreciation. This would simultaneously rein inflation and trigger
exports. If the US decides to cut rates again to quell a growing recession, then this
move will help to stem the additional flow that would have arisen in pursuit of interest
rate arbitrage.
∗ The aggressive monetary tightening policy along with investment bubble bursting
caused the growth in bank lending and IP to collapse, pushing Indian industry into a
prolonged slump. Admittedly, the central bank was ultimately able to control inflation,
but it did so at a very heavy price.
CRR is an inflexible instrument of monetary policy that drains liquidity across the board for all
banks without distinguishing between banks having idle cash balances from those that are
deficient. In case, CRR is not remunerated, it has a distortionary impact of a 'tax' on the banking
system. CRR is also discriminatory in that it has an in-built bias in favor of financial
intermediaries that are not required to maintain balances with the Reserve Bank. As against
repos/OMO that can be used flexibly to withdraw liquidity from surplus entitles while injecting
liquidity to the deficient ones, CRR is not a preferred option. Hence CRR as an instrument for
balancing monetary impact, should only be used under extreme conditions of excess liquidity
and that too when other options are exhausted.

BIBLIOGRAPHY
www.rbi.org.in
www.sify.com
www.thehindubusinessline.com
In.answers.yahoo.com
www.moneycontrol.com
www.mprofit.org
www.equitymaster.org
www.oecd.org
En.wikipedia.org
News.surfax.com
www.economictimes.indiatimes.com
In.reuters.com
www.indianexpress.com
www.hindu.com
www.rediff.com
www.iitk.ac.in
www.dbs.com
www.bis.org
www.financialexpress.com

ANNEXURE

Maintenance of Cash Reserve Ratio(CRR) -
Section 42(1) of the Reserve Bank of India Act, 1934
DBOD.No.BC. 34 /12.01.001/2001-02
October 22, 2001
Ashwin 30,1923 (saka)
To All Scheduled Commercial Banks

(Excluding Regional Rural Banks)
Dear Sir,
Section 42(1) of the Reserve Bank of India Act,

1934 - Maintenance of Cash Reserve Ratio(CRR)
Please refer to the paragraphs 54 and 57 of the Governor’s statement on Mid-term Review of
Monetary and Credit Policy for the year 2001-02 (circular No. MPD BC 210
/07.01.279/2001-02 dated October 22, 2001) regarding maintenance of Cash Reserve Ratio
(CRR) and payment of interest thereon. In this connection we advise as under:
2. (a) Reduction and Rationalisation of Cash Reserve Ratio (CRR)
All Scheduled Commercial Banks (excluding Regional Rural Banks) are at present required
to maintain with Reserve Bank of India a Cash Reserve Ratio (CRR) of 7.50 per cent of the
Net Demand and Time Liabilities (NDTL) (excluding liabilities subject to zero CRR
prescriptions) under Section 42(1) of the Reserve Bank of India Act, 1934. It has now been
decided to reduce CRR by two percentage points from 7.50 per cent to 5.50 per cent as
indicated below.
Effective fortnight beginning CRR on NDTL (percent)
November 3, 2001 5.75
December 29, 2001 5.50
(b) Withdrawal of exemptions in certain categories of

Liabilities from the maintenance of Cash Reserve Ratio
Simultaneous with the reduction in CRR, as indicated above, it has also been decided that all
exemptions on the liabilities will be withdrawn except inter-bank liabilities (as provided vide
our Circulars DBOD.BC.50/12.01.001/1996-97 dated April 15,1997 and
DBOD.No.BC.5/12.01.001/2001-02 dated August 07, 2001), for the computation of NDTL
(for requirement of maintenance of CRR) with effect from fortnight beginning November 3,
2001. Accordingly, it is now advised that the following exemptions provided earlier by the
Bank stand withdrawn for the computation of NDTL for the requirement of maintenance of
CRR with effect from the fortnight beginning November 3, 2001.
? Non-Resident External Rupee Accounts (NRE).

? Non-Resident Non-Repatriable Rupee Accounts (NRNR).
? Foreign Currency Non-Resident (Banks) Accounts [FCNR(B)].
? Exchange Earners’Foreign Currency (EEFC) Accounts.
? Resident Foreign Currency Accounts (RFCA).
? ESCROW Accounts by Indian Exporters.
? Foreign Credit Line for Pre-Shipment Credit Accounts in Foreign Currency (PCFC).
? Any other bank specific or general exemptions.
In view of the rationalisation of CRR prescription, however, it is clarified that the effective
CRR maintained by Scheduled Commercial Banks on total Demand and Time Liabilities
shall not be less than 3.0 per cent, as stipulated under the Act.
A copy of the relative notification DBOD No.BC 33/12.01.001/2001-02 dated October 22,
2001 together with a copy each of the earlier Notifications issued vide
DBOD.No.BC.45/12.01.001/96-97 dated April 15, 1997 and DBOD
No.BC.102/12.01.001/2000-2001 dated April 19,2001 is enclosed.
(c) Interest on cash balances maintained with

Reserve Bank of India under Cash Reserve Ratio
At present, all Scheduled Commercial Banks (excluding Regional Rural Banks) are paid
interest on eligible cash balances maintained with Reserve Bank at the rate of 6.0 percent per
annum under Section 42(1B) of Reserve Bank of India Act,1934. In the annual policy
statement of April 2001, it was announced that at a subsequent stage, interest would be paid
at the Bank Rate. It has now been decided that with effect from the fortnight beginning
November 3, 2001, all Scheduled Commercial Banks will be paid interest at the Bank Rate
on eligible cash balances maintained with Reserve Bank under provisio to Section 42(1) and
42(1A) of Reserve Bank of India Act, 1934.
Yours faithfully,
Sd/-
(R. C. Mittal)
General Manager.
Encls : 3
Endt. DBOD No. BC. 675 / 12.01.001/2001-02 of date.

Copy forwarded for information and necessary action to :
1. The Deputy General Manager, Department of Banking Operations and
Development, Reserve Bank of India, All Regional Offices,
2. The General Manager, Department of Banking Supervision, Reserve Bank of

India, All Regional Offices,
3. The Chief General Manager -in- Charge, Department of Banking Supervision,

Reserve Bank of India, Central Office, Mumbai,
4. The Adviser-in-Charge, Department of Statistical Analysis & Computer Services,

Reserve Bank of India, Central Office, Mumbai,
5. The Adviser-in-Charge, Department of Economic Analysis & Policy, Reserve

Bank of India, Central Office, Mumbai,
6. The Adviser-in-Charge, Monetary Policy Department, Reserve Bank of India,

Central Office, Mumbai 400 001, with reference to their circular No.MPD BC
210/07.01.279/2001-02 dated October 22, 2001.
(Sudarsan Oram)
Deputy General Manager
Telegrams
“BANKCHALAN”
TEL No. 2189131 - 39
Post Box No. 6089
MUMBAI
Reserve Bank of India

Central Office
Department of Banking Operations & Development
World Trade Centre-1, Cuffe Parade, Colaba
Mumbai 400 005.
DBOD.No.BC. 33 /12.01.001/2001-02
October 22, 2001
Ashwin 30,1923 (Saka)
NOTIFICATION
In exercise of the powers conferred by the proviso to Sub-section (1) of Section 42 of the
Reserve Bank of India Act, 1934 (2 of 1934 )(the Act) and in supersession of its Notification
DBOD No.BC.121/12.01.001/2000-01 dated May 12, 2001 the Reserve Bank of India hereby
specifies that the average Cash Reserve Ratio (CRR) required to be maintained by Scheduled
Commercial Banks (excluding Regional Rural Banks) shall, from effective dates mentioned
below, be at the percentage points as indicated thereagainst.
Effective date (i.e. the CRR on net demand and time

fortnight beginning from) liabilities (percent)
November 3, 2001 5.75
December 29, 2001 5.50
2. The Reserve Bank of India further directs that all exemptions granted to Scheduled
Commercial Banks (excluding Regional Rural Banks) under Sub-section (7) of Section 42 of
the Reserve Bank of India Act, 1934 (2 of 1934), stand withdrawn with effect from
November 3, 2001, except liabilities as computed under clause (d) of Explanation to Sub-
section (1) of Section 42, ibid. and as provided under Notifications issued vide
DBOD.No.BC.45/12.01.001/96-97 dated April 15, 1997 and vide DBOD
No.BC.102/12.01.001/2000-2001 dated April 19,2001.
(K.L.Khetarpaul)
Executive Director
Telegrams
“BANKCHALAN”
TEL No. 2189131 - 39
Post Box No. 6089
MUMBAI

Central Office
Mumbai 400 005.
DBOD.No.BC. 45 /12.01.001/96-97
April 15,1997,
Chaitra 25, 1919 (Saka)
NOTIFICATION
In exercise of the powers conferred by Sub-section (7) of Section 42 of the Reserve Bank of
India Act, 1934 (2 of 1934 ) Reserve Bank of India hereby exempts with from the fortnight
beginning April 26, 1997, every scheduled commercial bank (excluding Regional Rural
Banks) from maintenance of average Cash Reserve Ratio (CRR) specified in the Notification
DBOD.No.BC. 140/12.01.001/96-97 dated 19, October, 1996, with reference to its liabilities
as computed under clause (d) of Explanation to Sub-section(1) of Section 42, ibid.
2. The exemption stipulated above shall be subject to the CRR maintained by a
scheduled commercial bank at not less than 3 percent of its total of the demand and time
liabilities as computed under section 42 (1) of the Reserve Bank of India Act, 1934.
(J.R. Prabhu)
Executive Director
Telegrams
“BANKCHALAN”
TEL No. 2189131 - 39
Post Box No. 6089
MUMBAI

Central Office
Mumbai 400 005.
DBOD.No.BC.102 /12.01.001/2000-2001
April 19, 2001
Chaitra 29,1923 (Saka)
NOTIFICATION
In exercise of the powers conferred by Sub-section (7) of Section 42 of the Reserve Bank of
India Act, 1934 (2 of 1934 ) and in partial modification of its Notification DBOD
No.BC.45/12.01.001/96-97 dated April 15, 1997, Reserve Bank of India hereby exempts
inter-bank term liability of maturity of 15 days and above of all scheduled commercial banks
(excluding Regional Rural Banks) with effect from the fortnight beginning August 11, 2001
from the prescription of the maintenance of minimum Cash Reserve Ratio requirement of 3.0
percent of total of demand and time liabilities in India.
(K.L.Khetarpaul)
Executive Director
Changes made Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)

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BAANEE LUTHRA (15636)

SHILPA BABANAGARE (15602)

SIDDHARTH DAS (15638)

TUHINA TANDON (15635)

• Monetary Policy Framework in India 3

• Cash Reserve Ratio 6

• Statutory Liquidity Ratio 9

• Impact Of CRR And SLR On The Financial Framework 13

• Impact on Stock Markets 15

• Impact on Debt Market 17

• Impact on Foreign Exchange Markets 20

• Impact on Different Industries 21

• Impact on Common Man 25

• Monetary Policy of Mexico 26

• Monetary Policy of Korea 28

• Monetary Policy of South Africa 30

“Expression of feelings by words makes them less significant when it

We would hereby like to take the opportunity to thank our precious

We would hereby like to take the opportunity to express gratefulness

(BFIA – 3rd yr)

Tools of Monetary Policy

♦ Open Market Operations:

When the RBI Eases When the RBI Tightens

RBI buys government RBI sells government

It pays by crediting the It pays by debiting the

The bank in turn credits The bank in turn debits

The banking system has The banking system has

Downward pressure on Upward pressure on the

Influences other interest Other interest rates in

Gives the economy a Slows the economy and

Reserve requirement Impact on bank lending

Maintenance of incremental CRR

At present no incremental CRR is required to be maintained by the Scheduled Commercial

Liabilities not to be included for DTL/NDTL computation

d. Amount received from ECGC by invoking the guarantee.

f. Amount received from the Court Receiver.

Procedure for calculation of CRR

Maintenance of CRR on daily basis

With a view to providing flexibility to banks in choosing an optimum strategy of holding

b) In gold valued at a price not exceeding the current market price, or

Procedure for computation of demand and time liabilities for SLR

Valuation of approved securities for SLR

Less: Cash Reserve Ratio (7.50%) (7.50)

Less: Statutory Liquidity Ratio (25%) (23.125)

Less: Day to day liquidity required 4.375

Less: Loans (18.46%) 65.00

REASONS CAUSING A CHANGE IN RESERVE REQUIREMENTS

Factors leading to a rise in reserve requirements

¾ Expansion of money supply.

Factors leading to a cut in reserve requirements

¾ Lower currency expansion.

♦ Liquidity and Interest Rates

Thus we can say that

A hike in CRR decline in liquidity higher interest rates Rupee depreciates

A cut in CRR Rise in liquidity fall in interest rates Rupee appreciates

Thus increase in CRR:

• Increase in bond yields

Cut in reserve requirements:

A cut in SLR would lead to a:

Rise in reserve requirements:

Cut in reserve requirements:

¾ Impact on Banking Industry

♦ Net interest margins: