CRR: How to calculate Net Demand and Time Liabilities (NDTL) – the Theory

I usually promise to do follow-up posts and end up getting distracted by all the ideas fighting each other for brain space (there really isn’t very much) in my head. End result – a totally unrelated new post.

But not this time. (Those ADD pills must be working)

This indeed is a post related to CRR/SLR.

Being the nerd that I am, I’ve always wanted to know how the CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) are calculated for Scheduled Commercial Banks (SCBs). The numerators in these ratios are quite easily sourced from the RBI’s Weekly Statistical Supplement (WSS). It’s the denominator, the “Net Demand and Time Liabilities” (NDTL) of SCBs that is tricky to calculate. Let’s get right to it then.

Provided below is table number 4. “Scheduled Commercial Banks – Business in India” from the RBI’s WSS published on Sep 18th 2015. We’ll use the information in this table to calculate NDTL for SCBs outstanding on September 4th. (Note: this data is published with a fortnight’s lag).

Net Demand and Time Liabilities (NDTL)

Per the RBI Act, 1934 (Section 42), NDTL for the banking system is =

Liabilities to Others in India (#2 in table above) + Liabilities to the Banking system (#1 in table above) – Assets with the Banking system (#5 in table above)

Note: NDTL is = the formula above only when Liabilities to the Banking system > Assets with the banking system. If this is not the case and Liabilities to the Banking system < Assets with the Banking system, then NDTL is simply = Liabilities to Others in India.

From the table above (as on Sep 4^th):

Liabilities to Others = Rs. 97,341.5 Bn  (90, 280.5 + 2,380.2 + 4,680.8)

Liabilities to the Banking system = Rs. 1,806 Bn  (1,267.5 + 470.4 + 68.1)

Assets with the Banking system = Rs. 2583 Bn (1,772.1 + 207.7 + 232.8 + 370.4)

Since Liabilities to the Banking system are < Assets with the Banking system, NDTL = Liabilities to Others = Rs 97,341.5 Bn.  

I know exactly what you’re thinking right now - What’s so tricky about that? Right?

Read on....

The complication – NDTL calculation differs for CRR and SLR

The exact calculation of NDTL is slightly different for CRR and SLR. The difference lies in what is exempt i.e. the liabilities that a bank does not have to maintain CRR or SLR on.

Banks are exempt from maintaining CRR on the following...

.... meaning that they are NOT included in the NDTL calculation for CRR purposes.

1. Liabilities to the banking system in India.
2. Note: for CRR purposes, SCBs should not 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 exclude 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”.
3. Credit balances in Asian Clearing Union (US$) Accounts.
4. Demand and Time Liabilities in respect of their Offshore Banking Units (OBU).
5. The eligible amount of incremental FCNR (B) and NRE deposits of maturities of three years and above from the base date of July 26, 2013, and outstanding as on March 7, 2014, till their maturities/ pre-mature withdrawals.
6. Minimum of Eligible Credit (EC) and outstanding Long Term Bonds (LB) to finance infrastructure loans and affordable housing loans, as per the circular DBOD.BP.BC.No.25/08.12.014 /2014-15 dated July 15, 2014.

In English Please!

A very reasonable request since there were a lot big words, acronyms and jargon in the exemptions section above. Let’s demystify this section point by point.

• Lets start with the first 2 points. We know that NDTL = Liabilities to Others in India + (Liabilities to the Banking system – Assets with the Banking system), if “Liabilities to Banking system” > “Assets with the Banking system” or “Net Liabilities to the Banking system” are > 0. If not, then NDTL = “Liabilities to Others in India”. 

When calculating NDTL for CRR purposes, from the “Liabilities to the Banking system”, inter-bank term deposits /term borrowing liabilities of original maturities of 15 days and above and up to one year need to be excluded. Similarly, from “Assets with the banking system”, inter-bank term deposits and term lending of original maturity of 15 days and above and up to one year, need to be removed. Basically, we remove term liabilities and assets of 15 days – 1 year from the liabilities and assets side while calculating “ Net Liabilities to the Banking system”.

• Lets now consider point 3. The Asian Clearing Union (ACU) was established in ’74. The main objective of the ACU is to facilitate payments among member countries for eligible transactions on a multilateral basis, thereby economizing on the use of forex reserves and promoting trade among members. The Central Banks of Bangladesh, Bhutan, India, Iran, Maldives, Myanmar, Nepal, Pakistan and Sri Lanka are members of the ACU. Normally, ACU accounts are used to settle payments for export / import transaction between ACU member countries on deferred payment terms, subject to certain restrictions. Credit balances in ACU accounts in India are exempt from CRR maintenance, hence are subtracted for the NDTL calculated from the formula above.

• Moving on to point no. 4, “Offshore banking” refers to banking operations that cover non-residents.  An Offshore Banking Unit (OBU) is the branch of a bank located abroad or in the case of Indian banks, an OBU can also be located in a special economic zone (SEZ) within India and function under a special set of rules for encouraging exports from the SEZ. It is a "deemed foreign branch" of the parent bank and carries out international banking business involving foreign currency denominated assets and liabilities. While OBUs can raise funds from foreign currency deposits of non-residents (including NRIs), they cannot accept local currency deposits from residents. The demand and time liabilities of OBUs of Indian banks are exempt from CRR maintenance, and hence  subtracted for the NDTL calculated in the formula above.

• Lets move on to point no. 5. A Foreign Currency Non-Resident Bank [FCNR (B)] deposit is a term deposit account that can be maintained by NRIs and PIOs in foreign currency. A Non-Resident (External) Rupee (NRE) Account is one opened by an NRI in foreign currency that allows him/her convert the foreign currency into INR and repatriate funds to/transfer funds out of India.

Earlier, banks were required to include all FCNR (B) and NRE deposit liabilities for computation of NDTL and for maintenance of CRR. Then, starting from the fortnight beginning August 24, 2013, incremental FCNR (B) and NRE deposits with reference base date of July 26, 2013, and having maturity of 3 years and above, mobilised by banks were exempted from the maintenance of CRR and SLR. This meant, if a bank had a total FCNR (B) and NRE deposit base of say Rs. 100 as on July 26, 2013, and mobilized incremental deposits of Rs. 20, then that portion of Rs. 20 which had a maturity of 3 years and above, would not be included in NDTL and would qualify for CRR and SLR exemption.  Early last year however, from the reporting fortnight beginning March 8, 2014, the RBI announced that the exemption granted on incremental FCNR (B)/NRE deposits from maintenance of CRR/SLR was withdrawn. Now only incremental FCNR (B) and NRE deposits of maturities of three years and more mobilised between Jul 26, 2013 and Mar 7, 2014 qualify for the exemption from maintenance of CRR reserves.

• Finally, we move to point no. 6. In July 2014, in order to encourage banks to finance infrastructure loans and affordable housing loans, the RBI allowed eligible amounts under these categories to be exempt from the CRR requirement.  The details are provided in their circular DBOD.BP.BC.No.25/08.12.014 /2014-15 dated July 15, 2014.

Phew! This post has become much longer than I’d imagined....I’m going to save the more numerical part/ actual calculation of NDTL for our next post.

CRR and SLR

Have you ever nodded confidently in agreement with a friend as he/she waxed eloquent on CRR, SLR and other such terms ending in “R” that you didn’t quite understand?

I know I have.

Now that I’m old (-er) and grey (I’ve been greying since I was 18. L’Oreal hair dye is the secret to my apparent youth. Don’t tell anyone), I say the following alarmingly often and with an amusing (to many) lack of embarrassment.

“What does that mean?”

“I have no idea.”

“Whaaaaaaaat?” (Sometimes followed by words I cannot type on this blog without being judged).

Since you may not suffer from the same lack of embarrassment as I do, I’m going to help you out by demystifying CRR and SLR in this post.

Then you can have a “Kulwant Bhatia” moment. He’s the chubby, hilarious Sardar dude in this Indiabulls addvertisment below (youtube link provided). Be sure to check it out - if you don’t laugh, I’ll shave (whoops - sorry), I mean.....grow my hair.

                                                                                                                    

https://www.youtube.com/watch?v=kGz445o2KzU

What is CRR?

The Cash Reserve Ratio (CRR) is the proportion of a bank’s Net Demand and Time Liabilities (NDTL) that is has to keep as cash with the RBI. While we’ll explain in detail what comprises the NDTL of banks in another post, what it broadly refers to is total bank deposits. Hence, CRR is the % of total deposit funds that banks have to maintain as cash with the RBI.

The CRR is currently at 4%.  This means, of every Rs. 100 in deposits, a bank must keep Rs. 4 with the RBI.  It has Rs. 96 left for lending and meeting other regulatory requirements. Note: the CRR funds kept with the RBI earn no interest.

Objectives of CRR

The objectives of having a CRR requirement are:

• Ensuring that banks have adequate funds to meet payment/ withdrawal demands from their depositors.

• The CRR is also a tool of monetary control for the RBI. It can be used to increase/decrease money supply and manage inflation. For example, an increase in the CRR means that a higher proportion of bank deposits has to be parked as cash with the RBI. This means that banks have less money to lend which reduces the money supply through the “multiplier” effect (eminently deserving of a separate post which I will most certainly do). Lower money supply means less money is chasing the same number of goods (lower demand for goods), which helps lower inflation.                                                                                                                                                                    I’m going to explain this same process from the banks’ perspective. An increase in CRR means an increase in idle funds (remember – CRR funds don’t earn any interest) and a decrease in loanable funds for banks. In order to preserve profits, banks tend to increase lending rates. An increase in lending rates leads to a drop in demand for loans from retail and corporate customers, who consequently tend to spend/consume less which reduces the demand for goods & services. As a result, inflation tends to fall.

What is SLR?

The Statutory Liquidity Ratio (SLR) is the % of a bank’s NDTL that it has to maintain as investments in assets specified by the RBI, which include cash, gold and government securities. The SLR is currently at 21.5%. This means that of every Rs. 100 in deposits, a bank must invest Rs. 21.5 in SLR assets (mostly government bonds). Even thought the SLR is at 21.5%, Indian banks currently hold around 29-30% of their NDTL in SLR-approved assets/ securities.

Objectives of SLR

The objectives of having an SLR requirement are:

• To ensure that banks are able to return to their depositors, the full (par) value of their deposits at maturity, along with interest as and when promised. Besides the CRR, the RBI does this through the SLR by requiring banks to deploy a fixed % of their deposit funds in government securities (g-secs), considered the safest assets available.  In finance speak, the objective of SLR is to ensure the “solvency” of banks.

• The other objective is providing a large captive market for government bonds through the mandatory SLR requirement. This allows the government to finance its fiscal deficit at lower rates.  In the absence of the SLR requirement, banks would voluntarily invest a lower amount in g-secs, which would drive up yields and significantly raise the government’s borrowing costs.

• SLR can also be used to control the expansion of credit in the economy. When the SLR is lowered, banks have more funds available for lending. This allows banks to lower interest rates without impacting profit margins, which in turn leads to an expansion in bank credit. Bank credit expansion leads to increased economic activity/spending. This can also engender an increase in inflation. The opposite happens when the SLR is lowered.  

History

Till 2007, the minimum value of CRR was fixed at 3% and the maximum value was fixed at 20%. These limits were abolished in 2007 by an amendment of the RBI Act. Currently, the CRR is at 4%.

Similarly, before 2007, the maximum and minimum limits for the SLR were 40% and 25%. In Jan 2007, after the amendment of the Banking regulation Act, the minimum limit of 25% was removed. Today, the SLR is at 21.5%.

I’m going to do some related/follow-up posts soon.

Watch this space.

How bank deposit composition complicates transmission of Repo rate cuts in India

As promised, I’m doing a quick follow-up post on the complications in the transmission of Repo rate cuts to bank lending rates in India. The complication that I’m addressing here is the deposit composition of Scheduled Commercial Banks (SCBs) and how it affects the transmission of Repo rate cuts. 

Before discussing composition, here are the 3 main types of deposits offered by SCBs:

Savings Account Deposits:

Most of us (retail/ individual customers) have Savings accounts with banks where we receive our salaries and from where we make our daily living expenses. There are restrictions on the number as well as the amount of withdrawals from these accounts. Also minimum balances are required to be maintained in these accounts. Saving account deposits earn interest at a fixed rate decided by the bank. Currently most leading banks offer 4% per annum (interest is calculated on the daily balance).

Current Account Deposits:

Current Account deposits are used by businessmen or companies/firms etc. to conduct all the day-to-day transactions required to run their businesses. There are no restrictions on the number or amount of transactions in these accounts. These accounts do not earn any interest. Banks do levy certain service charges on these accounts for all the facilities that they provide.

Term Deposits or Fixed Deposits:

In a Term deposit, money is deposited for a certain tenure (7 days – 10 years or more) for which the depositor earns a fixed rate of interest. The fixed rate on the deposit is decided by the bank, and is usually directly proportional to the maturity of the deposit. The depositor cannot withdraw money from the deposit before maturity without paying a penalty.

Now that we know the main types of deposits offered, provided below is the deposit composition for SCBs in India (in Mar 2014): 

Source: Basic Statistical Returns of Scheduled Commercial Banks in India - Volume 43, March 2014.

Note: The % of current, savings and term deposits in total deposits is shown in parenthesis.

The data in the table above shows that in March 2014, of the total SCB deposits in India (~Rs 80 lakh Crore):

- Current A/C deposits stood at 9% (of total)

- Savings A/C deposits were 26.5%

- Term Deposits were 64.6%

Current Account and Saving Account deposits are also called CASA deposits. (No points for guessing that CASA stands for “Current Account Savings Account”). CASA ratio for a bank = (CASA deposits/ Total deposits). As shown in the table above, in Mar 2014, the CASA ratio for SCBs as a whole was = 9% + 26.5% = 35.5%. 

A higher CASA ratio is a favourable metric because it means lower cost of funds for a bank since no interest is paid out on current A/C deposits and the interest on Savings A/C deposits is usually just 4% (much lower that what is paid out on term deposits). The higher the CASA ratio for a bank, the larger the proportions of low cost funds in its deposit base, which means its average cost of funds is lower. This helps the bank achieve a higher Net Interest Margin (NIM) i.e. achieve higher profitability. NIM = interest income earned by bank – interest paid out by bank.

What happens when the RBI lowers the Repo rate? (Deposit side perspective)

When the RBI lowers the Repo rate, the cost of CASA funds remains the same because no interest rate is paid on current account deposits and the interest rate on savings accounts (4% currently for most) remains the same (banks don’t change this rate easily).

The change in the cost of funds happens in the term deposit segment. However, this change too is very sluggish. Why? Because term deposits are usually contracted at a fixed rate which the bank is liable to pay till the deposit matures. Even when the bank drops the interest rate it pays on new term deposits of similar maturity, it has to continue to pay the higher rates contracted on its existing term deposits till their maturity date.

Based on RBI data, the maturity composition of SCB term deposits in Mar 2014 was as follows:

Upto 6 months        : 12.6%

6 months – 1 year   : 14.3%     

1 -3 years                : 46.2%

3 years & above      : 26.9%

This data shows that 73% of term deposits of Indian SCBs have a maturity of a year or longer. So even if SCBs cut interest rates on new term deposits, 73% of their existing term deposit base won’t see any movement in interest rates (costs of funds for the bank) before a year. 73% of SCB term deposits = 73% * 64.6% = 47.2% of total SCB deposits.

Lets add the CASA ratio to this.

35.5% (CASA ratio) + 47.2% = 82.7%.

Bottom-line: Even when SCBs cut interest rates on new term deposits following a Repo rate cut, 47% of their total existing deposits don’t see any movement in interest rates (cost of funds) before a year, while 35.5% of their total deposits (CASA ratio) don’t see any movement in interest rates at all (time factor irrelevant). Overall, ~83% of total bank deposits see no movement in rates (cost of funds) for a year following a Repo rate cut.

I apologize for being repetitive - am just trying to underscore the fact that banks’ cost of funds doesn’t really respond much to a cut in Repo rate in the short term. This is why transmission of the cut to bank lending rates is hard. With cost of funds not really falling in the short term, cutting lending rates squeezes margins. 

“Why should a cut in Repo rate transmit to bank lending rates?” is NOT a stupid question.

Governor Rajan cut the Repo rate by 50 bps in the Monetary Policy Review on Sep 29^th, surprising markets that were expecting a 25bps cut. The Governor wants maximum transmission of the rate cut by banks (meaning he wants the cut in Repo rate to translate into an almost equivalent cut in the banks’ “base rates” – these are the benchmark rates on the basis of which banks lend money to borrowers). Note: in CY2015, the RBI has cut the Repo rate by 125 bps till date (from 8.00% to 6.75%), while top banks have cut their base rates by 60-70bps. So while transmission has happened, it has been incomplete.

Here’s why a cut in Repo rate doesn’t easily translate into lower bank base rates/ lending rates:

1) Repo funds form a very small percentage (less than or =1%) of the total deposits of banks – so little direct impact on cost of funds from a cut in Repo rate.

The banking sector can borrow upto 1% of its net demand and time liabilities (i.e. total deposits) from the RBI’s LAF (Repo) window. Repo funds are used by banks mainly to meet any short-term liquidity requirements (maintaining CRR for example). For bank base rates and consequently lending rates to go down, the average cost of deposits (the average interest rate that banks pay to their depositors) must fall.  Given that Repo funds form less 1% of banks’ total deposits, a lower Repo rate has a very small direct impact on the average cost of funds.

2) There’s indirect transmission of Repo rate cuts, but since most deposits are contracted at fixed rates, banks have to continue to pay these rates till maturity.  Lowering lending rates in this scenario impact margins.

We explained above how there’s little direct impact of a Repo rate cut on the cost of funds, and thus little transmission to lending rates.  There is however an indirect way that the transmission mechanism works through the debt market. When the Repo rate is cut, yields on government and corporate bonds fall. This means that investors now get lower returns from debt securities, which means that banks have leeway to cut deposit rates in line with the lower interest rate environment. The problem that arises now though, is that even when banks cut interest rates on new term deposits, since their existing term deposits were contracted at fixed rates, they have to continue to pay these higher contracted rates till these deposits mature. As a result, even when banks cut deposit rates, their cost of funds does not change much in the short term. This makes it hard for them to cut base rates/ lending rates, without impacting their NIMs (net interest margins). 

3) Lower Repo rate means lower yield on government securities which means lower treasury income from banks’ SLR securities. This actually puts pressure on banks to not cut lending rates. (Opposite of the desired impact)

When the RBI cuts the Repo rate, yields on government bonds fall almost immediately. While this provides banks with instant “capital gains” or mark-to-market gains from the increase in the value of their SLR portfolio (price of bonds inversely proportional to their yield), the interest income that they receive from their SLR assets goes down, thus impacting their Net Interest Margins (NIM). This actually discourages them from reducing their lending rates because they now have to make up for the loss of treasury income from their loan assets. This leads to low transmission of the Repo rate cut to bank lending rates.

Bottom-line: Transmission of Repo rate cuts is not as intuitive as it seems. Infact, transmission is a complicated, controversial subject.