CRR Shock, MSF Funding and an AFS-to-HTM Switch
On 5 August the RBI announces a 50 basis point increase in the cash reserve ratio, from 4.00% to 4.50% of net demand and time liabilities (NDTL), effective the fortnight beginning 16 August. A mid-sized private bank's NDTL on the last reporting Friday was Rs 84,000 crore. It holds no excess CRR balance, and its SLR holding is Rs 20,100 crore against a requirement of 18% of NDTL. Call money borrowings already average Rs 2,600 crore a day. Treasury holds Rs 1,400 crore of government securities in the available-for-sale (AFS) category with a modified duration of 3.2 years, and Rs 5,000 crore in held-to-maturity (HTM). Deposits are growing 11% year on year while advances are growing 14%, and the credit-deposit ratio is 78%. The treasurer proposes to fund the entire incremental CRR requirement from the marginal standing facility (MSF) for the first fortnight, and to shift Rs 500 crore of AFS securities into HTM so that no mark-to-market loss is recognised on them.
1. Compute the incremental CRR the bank must find and evaluate the treasurer's MSF funding plan. What alternatives exist, and how would you rank them?
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Step 1 – size the hole. CRR bites on NDTL: 0.50% x Rs 84,000 crore = Rs 420 crore. Since CRR is an average daily balance over the fortnight, the bank can shuffle the daily timing but cannot escape the level.
Step 2 – test the MSF plan. MSF is priced at the Bank Rate (repo + 25 bps) and is an overnight, collateralised window capped at 2% of NDTL, i.e. Rs 1,680 crore here. Rs 420 crore is technically available, but MSF is the ceiling of the LAF corridor – the most expensive marginal rupee in the system. Rolling it over for fifteen consecutive days also tells the regulator that the deficit is structural, not frictional. It is a bridge, not a plan.
Step 3 – rank the alternatives.
- Price and pace credit: advances growing 14% against deposits at 11% is the real problem; slowing disbursements funds the CRR at zero marginal cost.
- Call/notice market borrowing around the repo rate, building on the existing Rs 2,600 crore programme, kept within prudential limits.
- LAF borrowing against surplus SLR securities.
- MSF only for intra-fortnight mismatches.
Watch item: the RBI frequently neutralises a CRR hike with OMO purchases. The treasurer should check LAF/OMO operations before locking in overnight money for the whole fortnight.
2. The board asks why a CRR hike should push up call money rates at all, when the money is merely parked with the RBI. Explain the transmission, distinguishing CRR from SLR, and state what would neutralise the effect.
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Why the rate rises. CRR balances sit with the RBI in a non-interest-bearing account. That cash does not vanish – it is immobilised. A permanent, unremunerated absorption of Rs 420 crore removes lendable reserves from the interbank market, so the supply of overnight funds shrinks while demand is unchanged. With the corridor set at the SDF rate (repo minus 25 bps) as the floor and the MSF/Bank Rate (repo plus 25 bps) as the ceiling, a system-wide scarcity pushes the weighted average call rate towards the ceiling.
It is bigger than Rs 420 crore. Reserves are the base of deposit creation; a permanent drain reduces the multiplier effect, so the eventual liquidity impact exceeds the headline figure. This is why a 50 bps CRR move can move call rates by more than 50 bps when the system is already in deficit.
CRR versus SLR. SLR securities are also a statutory lock-in, but they are earning assets and can be pledged in the LAF or MSF. They therefore provide a borrowing conduit; CRR provides none. A bank can use SLR to raise cash; it cannot use CRR.
What neutralises it: an OMO purchase, a variable-rate repo operation, or a cut in the SDF floor of matching size. If the RBI buys Rs 420 crore of securities, the drain is offset and the call rate should stay near repo.
3. Should the board approve shifting Rs 500 crore of AFS securities into HTM in the same quarter? Give your view with the accounting, regulatory and governance reasoning.
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Quantify the loss first. A 50 bps upward yield move on a portfolio with modified duration 3.2 years gives roughly 0.50% x 3.2 = 1.6% price impact, i.e. about Rs 22.4 crore on Rs 1,400 crore of AFS holdings. The bank must know this number whether or not it shifts the securities.
Arguments against as proposed.
- The economic loss already exists. Reclassification does not eliminate it; it relocates it out of the profit and loss account. Supervisors read a reclassification made in the same quarter as the rate shock as accounting arbitrage, and RBI's investment-classification norms require a board-approved policy, prospective application, and no retrospective shifting of a position that has already depreciated.
- HTM is meant for securities the bank genuinely intends to hold to maturity, within the board-approved HTM limit. A mid-year transfer driven by yield movement contradicts that intent.
- The transfer does not help liquidity: HTM securities are the least usable for LAF purposes because selling them invites regulatory scrutiny.
A defensible position. Absorb the mark-to-market hit in AFS, use the investment fluctuation reserve built from prior gains, and keep HTM for long-dated, genuinely held paper. If a transfer is still considered, do it prospectively, with a board minute recording a genuine intent-to-hold rationale - not loss avoidance.