The impact of CRR on stock market | Economics | Forum

The CRR (cash reserve ratio) is the rate of the money the banks used to keep with the RBI for security without any interest.

How it will impact the banks profitability! For example if bank A collects 10000/- deposit from you then out of the 10000/- he has to keep Rs500 (at the rate of 5%) with the RBI. But central bank always does not pay interest on this deposit money. The net amount left with the bank will be 9500/- . if the CRR is getting hiked then RBI will suck the money from the bank in order to meet the trade deficit. Same time the bank will have money supply deficit to meet all the loan demand. Once the money supply will be reduced then the loan rates or lending rates will increase. 80% of the banks lending will be short term trade loan which used to settle on fortnight basis.

The increase in interest rate will directly impact the housing, experts, banks, automobile sell figure etc in the short term. Since market is more sensitive towards the short term reactions it can lead to the fall in the above sectors. The real jerk will be felt in the monthly sell figure and turnover of the above mentioned sectors. Continuous increase in the CRR may impact the quarterly profitability of the above sectors. Second point is that if it is inline with the increase in the interest rate in the cash deposits then it will directly impact the stock market since the big money will flow out from the high risk sector to the low risk sector resulting low participation in the market.

Repo and reverse repo rate: Repo rate is the interest rate at which the Central bank lends money to the banks. Repo window is a money lending window in which the banks used to take money from RBI at a pre specified interest rate to meet the loan, redemption or consumer demand. Reverse repo is the exactly opposite to repo rate. If excess of liquidity will be in the system then the central bank used to take money from the banking system with the exchange of fixed maturity Government of India security, deep discount bonds, zero coupon bonds etc.

How the banking system works in India? We have different type and structure of banking systems in India.

a. PSB(public Sector Bank)

b. Private Sector Banks

c. Banks govern by Corporations and local bodies.

d. Co-operative banks

All these banks including the Non Banking Financial Institutions, Mutual Funds, Insurance Companies, Stock Exchanges are under the supervision of the central bank (RBI).

RBI has common rule for the financial portfolio of the banks. Basic functionality of the banks are to receive the money from the general public in terms of deposit and to deploy that money in different financial activities like corporate lone, consumer lone, home lone, business lone etc. The general tendency of the financial institution is to earn more profit out of the investment. Hence they used to take higher risk for higher return. If the high risk investment becomes failure then this system will collapse and public saving will get affected. To maintain the safety in the system RBI monitor the investment portfolio of the banks from time to time and instruct the banks to take necessary step to safe guard the investors money.

Same way when the entire system used to be flooded with excess money supply by the depositors, RBI sucks out the excess supply from the system by the way of increasing the CRR. This money sucking mechanism also helps to curtail the inflation. If free money will be available in the system then banks may give for cheaper loan, which in return can fuel the consumer spending, and demand of essential and government subsidies commodities. This may lead to higher demand of precious essential commodity and low supply. Remember essential commodity are nature dependent where as the monetary system is public dependent. This rise in demand may fuel the inflation. To rein the inflation central bank suck out the cheap money from the system to keep a perfect equilibrium between the demand and supply.

The rise in CRR has its good and bad effect. In stock market prospective it has neutral effect if this hike is being taken for a good cause. If this hike is taken to repair the damage done in the system then it is bad for the market.