A Bank Facing a CRR Cut and a Deposit Outflow
A scheduled commercial bank in Assam reports total deposits of ₹500 crore, of which demand deposits are ₹200 crore and time deposits ₹300 crore. Its reserves with the RBI are ₹20 crore, exactly equal to the statutory requirement, so it holds no excess reserves. The cash reserve ratio (CRR) is 4%. The bank's loan book is ₹430 crore and non-performing assets are ₹18 crore. The RBI announces a 50 basis point cut in CRR. The treasury team estimates currency leakage at 20% of new deposits and voluntary excess reserves at 5%. On the same day, the bank loses ₹2 crore of deposits to a competitor. The branch manager wants to know how much new lending the cut can support. A local business chamber argues that the cut will immediately lower loan interest rates and revive demand.
1. Calculate required reserves before and after the CRR cut. What is the bank's excess reserve position after the deposit outflow?
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Before the cut: required reserves = 4% of ₹500 crore = ₹20 crore. Actual reserves are ₹20 crore, so excess reserves are zero. After the cut to 3.5%: required reserves on ₹500 crore = ₹17.5 crore, so ₹2.5 crore is released and becomes excess reserves. After the ₹2 crore deposit outflow, deposits are ₹498 crore and reserves fall to ₹18 crore. Required reserves = 3.5% of ₹498 crore = ₹17.43 crore. Excess reserves = ₹18 crore − ₹17.43 crore = ₹0.57 crore. The outflow absorbs most of the released liquidity, leaving very little room for new lending unless the bank attracts fresh deposits or reduces other assets.
2. Using the simple money multiplier, what maximum deposit expansion does the released ₹2.5 crore support? Why is actual expansion likely smaller given 20% currency leakage and 5% excess reserves?
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The simple deposit multiplier is 1/CRR = 1/0.035 ≈ 28.57. On ₹2.5 crore of released reserves, the maximum new deposit expansion would be 2.5 × 28.57 ≈ ₹71.4 crore. But this assumes no currency leakage, no excess reserves and that every loan is redeposited in the banking system. With currency leakage c = 0.20 and excess reserves e = 0.05, the adjusted deposit multiplier is 1/(0.035 + 0.05 + 0.20) = 1/0.285 ≈ 3.51. That gives 2.5 × 3.51 ≈ ₹8.8 crore. After the ₹2 crore outflow, excess reserves are only ₹0.57 crore, so the realistic expansion is closer to 0.57 × 3.51 ≈ ₹2 crore. The chamber's expectation of a large immediate credit expansion is therefore overstated.
3. Evaluate the chamber's claim that the CRR cut will immediately lower loan interest rates and revive demand.
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A CRR cut increases the reserves available to banks, but it does not automatically lower lending rates or expand credit. The bank may hold the released reserves as excess reserves, especially given the deposit outflow. Its ₹18 crore of NPAs may make it risk-averse. If credit demand is weak because firms and households are pessimistic, cheaper reserves will not force borrowing. Pass-through also depends on deposit competition, the repo rate and the bank's funding costs. The cut can support liquidity and may gradually lower rates, but an immediate revival is not guaranteed. Complementary measures-such as resolving NPAs, credit guarantees for small firms and clearer transmission of policy rates-would be needed for the cut to have a stronger effect.