Credit-deposit ratio and its implication

What is credit-deposit ratio (CDR)?
It is the proportion of loan-assets created by banks from the deposits received. In simpler words, credit-deposit ratio is loans divided by deposits. The higher the ratio, the higher the loan-assets created from deposits.

What is the implication?
high credit-deposit ratio could lead to a rise in interest rates?

Consider Bank ABC which has deposits worth Rs. 100 crores and a credit-deposit ratio of 60 per cent. That means Bank ABC has used deposits worth Rs. 60 crores to create loan-assets. Only Rs. 40 crores is available for other investments.

We know that the Indian government is the largest borrower in the domestic credit market. The government borrows by issuing securities (G-secs) through auctions held by the RBI.

Banks, thus, lend to the government by investing in these G-secs. And Bank ABC has only Rs. 40 crores to invest in G-secs.

If more banks like ABC have lesser money to invest in G-secs, what will the government do in case it needs to raise money to meet its expenditure.

The government has two options.
One, it can raise yields to make investment by banks in G-secs attractive.
Or two, force the RBI to take the securities into its books.

Both the options have a tendency to push up interest rates in the economy. How?

Yields on G-secs serve as a benchmark for interest rates on other debt instruments. A rise in the former, thus, pushes up interest rates on the latter.

Second option also leads to rise in interest rates in case RBI to take the securities into its books. This is Because, by doing so, the RBI releases fresh money into the system. If the money so released is large, ``too much money will chase too few goods'' in the economy resulting in higher inflation levels. This would prompt investors to demand higher returns on debt instruments. In other words, higher interest rates.