RBI to Use Cash Reserve Ratio More Actively for Liquidity Management and Rate Stability

 In a strategic shift, the Reserve Bank of India (RBI) is planning to use the Cash Reserve Ratio (CRR) more frequently as a regular liquidity management tool, rather than only during times of extreme financial stress, a person familiar with the central bank’s thinking told Reuters.

This marks a notable change in how the RBI handles excess cash in the banking system and aims to improve the transmission of monetary policy.

What’s Changing?

Traditionally, the CRR — which is the percentage of a bank's deposits that must be held with the RBI — has been used sparingly, typically during major liquidity crises. But with India's banking system more stable and deposits growing steadily, the RBI now sees room to make CRR adjustments more routine.

In a surprise move last week, the RBI announced a 100-basis point (1%) reduction in the CRR, to be implemented in four equal phases, bringing the ratio down to 3%. This step is expected to inject ₹2.5 lakh crore (around $29.25 billion) into the banking system.

Why CRR Is Making a Comeback

A source told Reuters that the CRR is a more efficient tool for managing liquidity than repeatedly using Open Market Operations (OMOs) or foreign exchange (FX) swaps.

Between December and May, the RBI had pumped nearly $100 billion into the banking system through such measures — its largest intervention of this kind in recent memory. Shifting toward CRR-based management can help avoid market yield distortions that often result from large bond purchases.

The source emphasized that while the CRR can release liquidity, it can also be raised again if needed — for example, in response to sustained foreign investment inflows.

Target: Balanced Interest Rates

A key reason behind this shift is the RBI’s effort to anchor short-term interest rates. In recent months, excess cash in the banking system caused the overnight call money rate to drop well below the RBI’s repo rate, which currently stands at 5.5%.

"The RBI wants the overnight rate to stay close to the repo rate," the source said, suggesting the central bank may soon begin variable rate reverse repo auctions to withdraw excess liquidity when required.

Yield Curve Concerns

The central bank is also reportedly uncomfortable with the 10-year government bond yield falling too low, as it could send confusing signals to markets and investors. This suggests the RBI may become more proactive in managing long-term interest rate expectations.

New Framework on the Way

The RBI is currently working on a revised liquidity management framework. Until it is finalized, the central bank will continue with its current operations, according to the source.

What This Means for You

• For Investors: A more active use of CRR may reduce bond market volatility and help maintain more predictable interest rates.

• For Banks: Liquidity may be easier to manage, but banks will need to stay alert for changes in CRR that could impact their available funds.

• For Borrowers: Stable interest rates mean better transparency in loan and deposit pricing over time.

The RBI’s renewed focus on using CRR as a core policy tool reflects a maturing financial system and a more proactive approach to liquidity and rate management. This is a smart, forward-looking move that could enhance both market stability and monetary policy effectiveness in the long run.