RBI’s Strategic Measures In 2023: Managing Liquidity, I-CRR, Credit Risk Weight & More

In response to the Covid-19 pandemic, central banks around the world have made several attempts to manage inflationary pressures while maintaining sufficient liquidity in the market. The Reserve Bank of India (RBI) was no exception and injected additional liquidity into the system to counter the negative impact of the pandemic on the economy. As a result, the size of the RBI's balance sheet significantly expanded.

“The persistence of such an expanded balance sheet far too long could have created macroeconomic and financial instability. It is worth noting that the Reserve Bank has successfully reduced its balance sheet size well in time. Illustratively, the Reserve Bank’s balance sheet swelled to 28.6 per cent of GDP in the financial year 2021 (FY21). With modulation in liquidity in the post-Covid period, the balance sheet size moderated to 23.3 per cent of GDP in FY23 and further to 21.6 per cent in the current financial year,” RBI stated in a notification.

This year, liquidity adjustment tools other than fixed repo operations were effectively utilised. In 2023, it used various tools such as incremental cash reserve ratio, variable repo rate and variable reverse repo rate operations to achieve different objectives. These tools were applied with precision and effectiveness to regulate the money supply and manage liquidity in the economy.

Withdrawal of Rs 2000 notes

One of the distinctive measures taken by the RBI was the discontinuation of the Rs 2000 denomination notes. “In pursuance of the “Clean Note Policy” of the Reserve Bank of India, it has been decided to withdraw the Rs 2000 denomination banknotes from circulation,” RBI said in a notification dated 23 May 2023.

This move had significant implications for the banking system, as a substantial amount of currency was expected to return to the formal financial system. More money in the banking system implies more money to lend and as a result more liquidity in the market. Therefore RBI brought sufficient measures to prevent this from happening.

“Efficient liquidity management requires continuous assessment of the level of surplus liquidity so that additional measures are taken as and when necessary to impound the element of excess liquidity. Accordingly, it has been decided that with effect from the fortnight beginning 12 August 2023, scheduled banks shall maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between 19 May 2023 and 28 July 2023,” RBI stated in a notification.

What Is The Incremental Cash Reserve Ratio?

In pursuance of the Governor’s monetary policy statement of 10 August 2023, scheduled banks were required to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between 19 May 2023 and 28 July 2023. The measure was intended to absorb the surplus liquidity generated by various factors, including the return of Rs 2000 notes to the banking system. It was indicated that the I-CRR was a temporary measure for managing the liquidity overhang.

The I-CRR impounded about Rs 1.1 lakh crore from the banking system. The I-CRR was reviewed on September 8 and had been discontinued in a phased manner, ending on 7 October 2023.

Along with I-CRR, the RBI also conducted multiple variable repo rate(VRR) and variable reverse repo rate(VRRR) operations of distinctive volumes during the year 2023. RBI cites, “A 14-day term repo or reverse repo operation at a variable rate and conducted to coincide with the cash reserve ratio (CRR) maintenance cycle would be the main liquidity management tool for managing frictional liquidity requirements.” This in turn led to a liquidity crunch in the banking system.

Relation of I-CRR And VRRR To MSF And SDF 

RBI also addressed the issue of skewed liquidity which was a consequence of I-CRR.  “Moderation in excess liquidity conditions as a result of the combined impact of I-CRR and advance tax outflows in September has resulted in greater recourse to the marginal standing facility (MSF) by banks. Elevated levels of MSF borrowings amidst substantial funds parked under the standing deposit facility (SDF) are symptomatic of skewed liquidity distribution in the banking system,” RBI mentioned.

RBI further added that this was reflected in the firming up of the weighted average call rate (WACR) the operating target of monetary policy.

“In recent months, banks have preferred to place funds under the overnight SDF instead of offering them in the main 14-day variable rate reverse repo (VRRR) operations. It is imperative that banks assess their actual liquidity requirements over the reserve maintenance cycle and bid accordingly in the auctions under main 14-day VRRR operations,” RBI highlighted in September.

RBI hence suggested that banks having surplus funds should explore lending opportunities in the inter-bank call market rather than passively parking funds in the SDF at relatively less attractive rates. “A greater volume of call money transactions would not only help in deepening the inter-bank money market but also lower the recourse of deficit banks to the MSF,” the central bank emphasised.

Then to address the situation RBI proposed the reversal of MSF and SDF.

“We to address this situation, have decided to allow reversal of liquidity facilities under both SDF and MSF even during weekends and holidays with effect from 30 December 2023. It is expected that this measure will facilitate better fund management by the banks,” the RBI stated in a notification on 8 December 2023.

In response to the Covid-19 pandemic, the Reserve Bank of India (RBI) lowered the credit risk weight for different types of loans to facilitate lending by banks and non-banking financial companies (NBFCs). However, this year the RBI has reset the credit risks assigned to these loans to their pre-Covid levels.

Increase In The Credit Risk Weight

RBI increased the credit risks assigned to consumer credit given by banks and NBFCs by 25 basis points.

“Consumer credit attracts a risk weight of 100 per cent. On a review, it has been decided to increase the risk weights in respect of consumer credit exposure of commercial banks and NBFCs (outstanding as well as new), including personal loans, but excluding housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery, by 25 percentage points to 125 per cent,” the central bank mandated in a circular.

Establishment Of Cloud Facility And Fintech Repository

The Reserve Bank of India (RBI) is not only focusing on monetary policy but also keeping a close watch on the rapid advancements in technology. To streamline these developments, RBI has formulated regulatory compliances.

“The RBI is working on establishing a cloud facility for the financial sector in India. The cloud facility will be set up and initially operated by Indian Financial Technology and Allied Services (IFTAS), a wholly-owned subsidiary of RBI. Eventually, the cloud facility will be transferred to a separate entity owned by the financial sector participants,” RBI stated.

RBI has also decided to set up a fintech repository which will be operationalised under the Reserve Bank Innovation Hub (RBIH) from 1 April 2024.

“For a better understanding of the developments in the FinTech ecosystem to appropriately support the sector, it is proposed to set up a Repository for capturing essential information about FinTechs, encompassing their activities, products, technology stack, financial information etc. FinTechs would be encouraged to provide relevant information voluntarily to the Repository which will aid in designing appropriate policy approaches,” the RBI mentioned. 

Despite the changing times, there has been one constant throughout the entire year 2023 and that is the policy rate.

Stating what is expected from the year 2024, IDFC First Bank stated, “We continue to expect that RBI will lag the Fed in terms of timing and quantum of rate cuts as the interest rate differentials are at historical lows. RBI rate cut cycle is expected to start from August or October 2024 and the quantum of cuts will be lesser than the US. India’s Headline CPI inflation is expected to move towards the 4 per cent target only from Q2FY25 onwards. Meanwhile, growth in India remains on a relatively stronger footing, providing policy space to focus on inflation.”