Cash Reserve Ratio (CRR) is the minimum percentage of its total deposits that it must maintain as cash or cash equivalents with the Reserve Bank of India (RBI). The cash can either be held by the bank in its own vaults or parked with the RBI, on which it earns no interest. The bank cannot use this reserve to expand credit or to pay off debts.
The RBI uses it as one of the many monetary policy tools at its disposal to manage liquidity pressures and money supply. The RBI periodically reviews and determines the CRR rate. The CRR regulation is applicable only for scheduled commercial banks, but does not apply to non-banking financial companies (NBFCs) and regional rural banks (RRBs).
The current CRR rate is 4.5%. This means that every scheduled commercial bank is required to maintain 4.5% of its net demand and time liabilities (i.e. deposits) with the Reserve Bank of India as cash or cash equivalents. The CRR rate is calculated for a bank on a fortnightly basis, which means that a bank’s compliance with the CRR limit is evaluated after every 14 days.
Did You Know?
The CRR rate was last changed on 4th May, 2022. The CRR rate was increased by 50 basis points from 4% to 4.5%. It has remained unchanged ever since.
CRR is an important monetary policy tool that is used by the RBI to control liquidity. When RBI increases the CRR, banks have less funds to lend. This increases the cost of borrowing as a result of which less money goes into circulation. This can help contain inflation, but may also reduce the pace of economic growth. On the other hand, when CRR is reduced, banks have more funds to lend. This injects more liquidity into the market, thereby increasing the pace of growth.
Currently, the cash balance to be maintained by a bank with RBI needs to be 4.5% of its Net Demand and Time Liabilities (NDTL). This means that for every ₹100 deposited with a bank, ₹4.5 must be parked as cash either in the bank’s vault or with the Reserve Bank of India (RBI).
The primary objective of cash reserve ratio is to ensure that commercial banks have sufficient liquidity to meet the cash withdrawal demands of their depositors and other obligations.
Here are some of the other objectives of Cash Reserve Ratio (CRR):
RBI uses CRR as a monetary policy tool to control inflation. By increasing CRR, RBI can force banks to park more money with it, which in turn reduces their ability to lend money to borrowers. This increases the cost of borrowing, reduces the supply of money into the markets, and thereby helps bring down inflation.
The RBI changes CRR from time to time to control inflation and liquidity risks. RBI can change it not only to stay in line with its monetary policy and fiscal goals, but also to ensure that depositors have a safety net, in case there is a sudden surge in demand for funds through withdrawals. It also helps keep banks solvent and prevents a build up of non-performing assets.
In the event of failure to comply with RBI’s Cash Reserve Ratio norms, a bank will be penalised as follows:
Let us understand it better with an example. If the CRR norm for a bank for a particular day was ₹500 Crore and it managed to maintain ₹450 Crore for the day, then the penalty will be applied only on ₹50 Crore (500-450) and not on ₹450 Crore. For the first day, a penalty of 3% p.a. will be applied. But, on every subsequent day, the fine will be increased to 5% p.a. + the bank rate.
The calculation for CRR depends on a bank’s net demand and time liabilities (NDTL). In simple words, NDTL can be defined as the total deposits of a bank kept with the public and other banks minus other banks’ deposits. Liabilities that constitute NDTL include current deposits, fixed deposits, gold deposits, cash certificates, demand drafts, and dividends among others.
There is no specific mathematical formula for calculating CRR. It is simply the percentage of a bank’s NDTL that it must hold as cash reserves. Currently, it is 4.5%.
So, Cash Reserve Ratio (CRR) = Percentage of a bank’s total deposits i.e. NDTL held as cash or cash equivalents
Calculating CRR is quite simple. Let’s understand it with an example.
Let’s assume that a bank has ₹500 crore in total deposits. Let us also assume that the CRR is 4.5%.
The minimum Cash Reserve Ratio that the bank must meet is 4.5% of ₹500 Crore = 4.5/100×500 Crore= ₹22.5 Crore
So, the bank will have to hold ₹22.5 Crore as cash in its vault or parked with the RBI. This amount cannot be used by the bank for investment and lending.
When the RBI increases the cash reserve ratio (CRR), commercial banks are forced to hold a larger percentage of their total deposits as cash with the central bank. As a result, banks have less money available to lend or invest, which can lead to a decrease in the supply of credit in the economy. This can slow down the economy, as it becomes more difficult for individuals and businesses to access credit. But, sometimes the RBI needs to use this strategy to control inflation and oversupply of money.
CRR is one of the most powerful monetary policy instruments available to the RBI to control inflation and overcirculation of cash.
The Reserve Bank of India enhances the CRR levels that help reduce the amount of money that commercial banks have to lend. In turn, it lessens the money supply in the economy. Although it can temporarily slow down the country’ economy, it is an effective ploy to control inflation.
When the cash reserve ratio increases, banks reduce the expansion of credit. As a result, this will make people keep more deposits in their bank accounts. It forces banks to increase the rate of interest, thereby discouraging borrowers from applying for credit.
So, with higher interest rates, loan expenses increase, thereby drying up the availability of funds for borrowing.
The major differences between Cash Reserve Ratio and Statutory Liquidity ratio are as follows:
|Meaning||CRR is a certain portion of the total deposits that the commercial banks keep as a reserve with the central bank.||SLR refers to the portion of their deposits that banks are supposed to hold as liquid assets, including cash, sovereign bonds, gold, and other government-approved securities|
|Form||Cash and cash equivalents||Liquid Assets|
|Use||To control liquidity||To control credit expansion|
|Held with||Central Bank or RBI (Reserve Bank of India)||Bank itself|
|Returns||Banks earn no interest on their CRR reserves||Banks may earn interest from their SLR reserves|
CRR or Cash Reserve Ratio is the minimum stipulated percentage of deposits that commercial banks must hold with the Reserve Bank of India as cash or cash equivalents. Central Banks use CRR to control the interest rates for lending and for controlling money supply in the markets.
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Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are both important concepts in banking. While CRR is the reserve that banks maintain with the RBI, SLR is the reserve that the banks must maintain themselves before offering credit. Moreover, banks must maintain SLR in the form of cash, gold and other securities, unlike CRR, which must be held as cash.
The current cash reserve ratio set by the RBI is 4.50%. The RBI keeps on changing this value based on various factors.
The CRR is set and maintained by the Reserve Bank of India. They keep on changing the CRR on a fortnightly basis.
The Cash Reserve Requirement is calculated as the CRRs percentage of the NDTL. For instance, let us assume that the CRR is at 4% and the NDTL of a bank is Rs. 200 crore.
The Cash Reserve Requirement for the bank would be: Rs. [(4 / 100) x 200 crore)] = Rs. 8 crore
When RBI increases the CRRR, banks are left with fewer funds to sanction loans and make investments. The reduced cash flow helps in bringing down inflation.
There is no upper or lower limit on CRR. Till 2006, the lower and upper CRR limits were 3% and 20% respectively. However, it was abolished and ever since there has been no upper cap.The CRR rate is 4.5%.
There is no minimum limit. It used to be 3% until 2006 when the government decided to do away with the lower limit.
The full form of CRR is Cash Reserve Ratio
Yes, CRR must be maintained by all banks. However, regional rural banks and NBFCs have an exemption.
The Reserve Bank of India has the sole authority to determine and control CRR and SLR.
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