Language of Money - Series 2C

What is cash reserve ratio?

Cash reserve ratio (CRR) is that slice of a bank's deposits, which the bank has to compulsorily deposit with RBI.

A CRR of five per cent means that out of every Rs 100 which the bank gets as deposit, Rs 5 have to be deposited with RBI. Interestingly, RBI does not pay any interest on this money to banks. When RBI wants to reduce liquidity from the system, like in times of high inflation, it increases the CRR.

While repo rate acts as an indirect measure to control liquidity, CRR is a blunt weapon, which directly sucks liquidity from the system.

Consequently, when RBI is adopting an expansionary monetary policy, that is, when reviving growth and reducing inflation is not the main agenda, the CRR is reduced. Again, this has a direct and immediate impact on the liquidity.

In times such as these, when banks have plenty of funds but not much demand for money, they buy G-Secs more than the stipulated 24 per cent with the excess cash. As seen in the previous article, when interest rates go down, bond prices go up. So banks make a lot of money by their treasury operations in a falling interest rate scenario.

In this quarter (a three-month period after which most companies announce their results) keep an eye on bank results, and you will see the 'other income'; that is, treasury income contributing to banks' profits.

As interest rates reach their lows and consequently bond prices reach their highs, banks sell G-Secs (that is also the time when bonds are making headlines and sadly average retail investors are entering then, as was shown in the previous article!) and keep money ready for lending. This is because low interest rates attract consumers and corporates and banks start advancing loans to these entities.

This is not something new. Banks make money when rates are high as well as when rates are low. This has been happening for years. And if banks can do this so can we. But how many of us do this?

It is only the lack of knowledge of this language of money that the average investor never makes big money out of this 'officially available insider information'. Retail investors invest on some silly 'tips' or 'inside information' from their brokers but conveniently ignore such big tips the biggest insider in the economy -- RBI -- gives.

In the next article we will focus on the mathematics of debt markets. We have been saying that bond prices are inversely proportional to interest rate movement. In the article next week we will see why this happens.