Cash Reserve Ratio (CRR): Meaning, How It Works And Its Impact On Depositors

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!

What is the Cash Reserve Ratio? 

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

Why Does a Bank Need to Maintain CRR? 

• Reserve Bank of India focuses on controlling liquidity in the financial banking system. It maintains the cash flow of the whole country by using various financial instruments to uphold the economy. CRR is one such instrument.
• Maintaining CRR in a systematic way will control the liquidity of the country. Nevertheless, it can be beneficial for the commercial banks, too, as by no means they will suffer from fund shortages. 
• Another vital reason to maintain CRR is that it controls inflation in the economy. In case of a sudden rise in the price of products, the RBI increases CRR to lower the money flow and investment, thereby lessening inflation.
• In the economic system, Cash Reserve Ratio is inversely related to the country’s liquidity. It means when a high level of CRR is reserved with RBI, economic liquidity will get reduced. Similarly, a low level of CRR kept with RBI will raise liquidity.  

Also Read: Prime Lending Rate, MCLR, RBI Base Rate & How Do These Rates Work

How Does CRR Affect Depositors or Customers? 

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. 

How does CRR Effects the Economy? 

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. 

Impact of CRR or Cash Reserve Ratio in India on Interest Rate 

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. 

Effect of Increase in CRR 

The following effects will occur when CRR increases:

• Banks will have to keep fewer funds and resources when CRR is raised.

• Commercial banks will keep inadequate funds since RBI asks them to hold large liquid cash. 

• Banks will be forced to increase interest rates on credit items like home loans, car loans, personal loans, etc. 

• An increase in interest rate will also raise the Equated Monthly Instalments (EMIs). 

Effect of Decrease in CRR 

The following effects will occur when CRR decreases:

• When CRR decreases, the supply of money will increase due to more funds from commercial banks. 
• A rise in the money supply will increase the chance of causing inflation.
• If CRR decreases, a reduction of funds will occur in the economy, and the supply of money will be affected.

Difference between Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) 

The major differences between Cash Reserve Ratio and Statutory Liquidity ratio are as follows: 

Also Read: What Is The Difference Between Secured And Unsecured Loans?

Final Word

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. 

FAQs on Cash Reserve Ratio

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.