CRR (Cash Reserve Ratio) is the amount of money every bank has to deposit to the RBI (Central bank). It affects the banks operating margin in macro level.
Now Question arises how?, The answer is very simple. It is now around 6%. This means if a bank has Rs. 1 crore as total sum of deposits with the bank then they have to keep 6 lakhs with RBI as a reserve. Basically CRR is necessary to have control over the money freely available that is control Liquidity.
In India hardly very few people are aware that more liquidity leads to more inflation because if you have money you often afford to spend it which means more demand which in-turn leads to more price and hence inflation. By raising the CRR the banks has to keep more money from their Portfolio with RBI and help to control liquidity and there by inflation.
CRR plays a vital role on the stock value of banks and there exists a negative correlation between them.
IMPACT OF CRR ON STOCK MARKETS
A Hike in CRR leading to rising interest rates with several other implications:
- It create the bearish impact on economy ; this effectively means that investment activity and production of goods and services, gets adversely effected
- Since some investors tend to take risk and invest in the stock markets, higher interest rates increase the expectation of returns from the stock markets; this has the impact of lowering the current stock prices.
- An overall decline in stock prices has a cascading effect as risky positions are unwound (on account of meeting margin requirements), leading to still lower stock prices
So, for a short term, higher interest rates should negatively impact stock market sentiment. For a long term, however the expectations of returns from the stock markets remain unchanged.
It's difficult to predict that how the stock markets will move; or till what extent the markets will move.
CRR hike has the potential to significantly make a dent in equity markets. The risk involved in such cases is that the RBI is likely to end the growth party in India. The RBI move might result in lower PE for the market.
In Indian equity markets there are three levels of macro risk; a high P/E, a relatively overvalued rupee and interest rates that have stayed relatively low considering the level of economic growth, and we associate these things with growth. The P/E multiples are high because growth is strong, the rupee has been firm because strong growth has attracted capital and that capital has helped keep interest rates low. With CRR hike RBI is about to end the growth party and if growth begins to slow down then you are likely to see a lower P/E, a low rupee and a potentially higher interest rates.
Source: Google
