Although the Reserve Bank of India held off on premature rate cuts due to persistent inflation, it provided significant relief to market participants by announcing a 50-basis-point reduction in the cash reserve ratio (CRR) on Friday. The move is expected to ease the liquidity situation in the system and boost the profitability and net interest margin of financial companies.
The RBI will cut the CRR in two equal tranches of 25 bps each, effective from the fortnight beginning December 14 to December 28. After two reductions, the CRR requirement will return to the pre-pandemic level of 4 percent in the current financial year. It will release primary liquidity of about ₹1.16 lakh crore to the banking system.
Experts hailed the decision, describing it as the right move to address the current unfavourable growth-inflation dynamics when inflation is high and growth is losing steam. The CRR cut is aimed at preventing excessive liquidity draining from the economy, which typically weighs on economic growth.
Banks are required to keep a certain percentage of their total deposits with the RBI to ensure the stability and liquidity of the banking system. The CRR also acts as a tool for the RBI to manage money flow and inflation.
This money reserve of banks with the RBI is the cash reserve ratio (CRR). This money is not available for lending but is kept aside to ensure that banks have enough liquidity to meet customer withdrawal demands.
Simply put, a cut in CRR means banks will have more money to lend now as they will be required to keep less money as reserves with the central bank.
Banks' increased lending accelerates economic activities as it can help stimulate demand for credit, supporting growth in several sectors such as manufacturing, infrastructure, housing, and consumer goods.
With a cut in CRR, banks earn interest on the funds that would have otherwise been parked with the RBI at no interest. This enhances banks' profitability.
"The CRR cut would take the rate back to levels before the start of the hiking cycle in April 2022. This will boost the credit supply. It could translate to a 2-6bp improvement in domestic banks’ net interest income, assuming all funds are deployed for loans," said Radhika Rao, senior economist at DBS Bank.
Pandya of StoxBox said that PSU banks like SBI, Bank of Baroda, and Canara Bank stand out as attractive opportunities at current valuations.
Pandya finds SBI a compelling buy due to its robust performance, improved NPA ratios, and positive asset quality trends despite concerns around unsecured retail loans. Furthermore, SBI’s healthy loan growth of 15 percent year-on-year well above the industry average, and its diversified, granular loan book provide added resilience, reducing the likelihood of negative surprises in credit costs.
(By arrangement with livemint.com)
