All commercial banks in India maintain a specific percentage of total bank deposits as per the guidelines of the Reserve Bank of India (RBI) known as the Cash Reserve Ratio (CRR). This helps reduce liquidity risks. Read on to get an in-depth understanding of the Cash Reserve Ratio, its importance and impact on interest rates, what happens when CRR increases or decreases and what is the current CRR. Read on!
The cash held as reserves against total bank deposits is termed as Cash Reserve Ratio (CRR). The RBI keeps a particular percentage of money with commercial banks in this system. The sum of money is sent chiefly directly to the central bank, but it is often preserved in the bank’s locker.
Banks can neither use CRR money on investing activities nor lend it to the borrowers or loanees. Nevertheless, RBI uses the CRR ratio as a quantitative instrument to normalise inflation or deflation in the country.
The formula for computing CRR is:
Cash Reserve Ratio (CRR) = Reserve Requirement x Bank Deposits
Also Read: Prime Lending Rate, MCLR, RBI Base Rate & How Do These Rates Work
CRR affects depositors or customers associated with the bank. For example, when a depositor invests in a bank for inventory, a greater rate of CRR will keep his/her deposited money safe.
One of the best financial instruments followed by the RBI to control inflation, supply of money, cash flow etc., is the Cash Reserve Ratio (CRR). If the level of CRR increases, the amount of liquidity decreases and vice-versa.
In case of inflation, the Reserve Bank of India enhances the CRR level alongside diminishing the borrowing funds of commercial banks. In turn, it lessens the money supply in the economy. Although it causes adverse effects on the country’s core economy, still it controls the burden of inflation.
Likewise, when RBI figures out some funds are needed desperately, they reduce the CRR level, enhancing credit facilities for the commercial banks. This enables banks to offer more and more loans to borrowers and businesses. Thus, money supply and productivity in the economy get better.
When CRR increases, banks reduce the flow of funds. As a result, this will make people keep more deposits in their bank accounts. It will make banks increase the rate of interest, thereby disallowing borrowers from applying for credit. Point to be noted that interest rates are directly related to loan expenses. Therefore, if the interest rate is higher, loan expenses will also increase.
The following effects will occur when CRR increases:
The following effects will occur when CRR decreases:
The major differences between Cash Reserve Ratio and Statutory Liquidity ratio are as follows:
Prospect | CRR | SLR |
Meaning | CRR is a certain portion of the money that the commercial banks keep as a reserve with the central bank. | SLR refers to the funds that banks require to maintain their liquid assets like cash, securities. etc. |
Form | Cash and cash equivalents | Liquid Assets |
Use | To eliminate excess fund from the economic system | Ensuring creditworthiness of commercial banks. |
Control | Central Bank or RBI (Reserve Bank of India) | Bank itself |
Returns | Banks earn no interest as a return on the fund in case of CRR. | Banks earn interest as a return on the funds in case of SLR. |
Also Read: What Is The Difference Between Secured And Unsecured Loans?
CRR or Cash Reserve Ratio determines the percentage of deposits held by the commercial banks as reserves. Central Banks use CRR to control the interest rates and lending rates of a country by adjusting money whenever necessary.
Ans: The SLR or Statutory Liquidity Ratio is the part of the money that a bank has to maintain in the form of securities, cash or gold. In comparison, CRR or Cash Reserve Ratio is the minimum amount of a bank’s deposits held in cash.
Ans: CRR is one of the best financial instruments used by the Reserve Bank of India (RBI), and its present rate is 3%.
Ans: The Reserve Bank of India (RBI) controls the CRR per the Monetary Policy Committee.
Ans: The objectives of Statutory Liquidity Ratio are:
– Controlling expansion of bank credit
– Offer incentives to the financial institutions to encourage investment in government securities.
Ans: Cash Reserve Ratio is determined by the percentage of the bank’s net demand and time liabilities (NDTL). Net demand refers to the total demand, whereas time liabilities refer to the number of deposits.
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