Know All About Cash Reserve Ratio or CRR

The Cash Reserve Ratio (CRR) is periodically reviewed and fixed by the Reserve Bank of India, based on its Monetary and Credit Policy. CRR is used extensively to control inflation levels and manage the supply of money and liquidity in the country. 

What is Cash Reserve Ratio or CRR?

The RBI mandates that banks set aside a certain portion of their total deposits in the form of cash. This stipulated amount kept in reserve is called the Cash Reserve Ratio. It is either stored in a bank vault or sent to the RBI. Banks don’t earn any interest on this money and they cannot utilise it for lending or investment purposes. 

Calculation of Cash Reserve Ratio

A bank’s liabilities are made up of the following:

  • Demand liabilities like demand drafts (DDs), current deposits, cash certificates, and others.
  • Time liabilities, such as fixed deposits (FDs), gold deposits, and so on.
  • Other liabilities, such as dividends, deposit interest, etc. 

If the current CRR rate is 5%, a bank must store 5% of the Net Demand and Time Liabilities (NDTL) it holds, in the form of cash. Demand deposits are liabilities that need to be paid on demand, while time deposits are repaid on a certain date, usually on maturity. Unlike demand deposits, the latter cannot be withdrawn as per need. 

The cash reserve requirement is calculated as:

Reserve Requirement = Deposits x Reserve Ratio 

wherein, 

CRR = (Cash/NDTL) x 100

CRR tells us how much credit money banks can make by lending out customer deposits. If a bank holds 10% of its total deposits in reserve, it can lend the remaining 90%, which goes into the banking system in the form of new deposits. 

Objectives of Cash Reserve Ratio

The main purposes of CRR are mentioned below:

  • Cash reserves ensure the security of the deposits that will be readily available when customers need them back. 
  • CRR keeps inflation under control. During times of high inflation in the economy, the RBI increases the reserve ratio so that banks can keep more money in reserve and have lesser money to lend.
  • The base rate or the rate below which banks cannot lend to any borrower is influenced by the CRR.

Importance of Cash Reserve Ratio 

When customers make deposits in banks, this money is lent to other customers. Banks prefer to lend more and keep limited cash with them for miscellaneous purposes. The ability to lend more means better earnings for them in the form of interest charged from borrowers. 

However, on the flip side, if a bank lends a large portion of its funds to borrowers, it might be unable to meet a sudden demand for withdrawals from depositors. The RBI, therefore, mandates a CRR for banks to ensure they do not face a shortage of funds in times of exigency.   

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During periods of high inflation, the government ensures there is no excess flow of money in the economy. Accordingly, the RBI increases the CRR, which reduces the amount of money available to the banks. A higher CRR can adversely affect the economy with lesser availability of funds for loans, automatically slowing down investment. 

On the other hand, whenever the government needs to pump funds into the system and boost the economy, the RBI lowers the CRR rate. This helps the banks provide loans to many businesses and industries for investment. 

Hence, CRR is inversely proportional to the supply of money and investment in the economy.

Advantages of Cash Reserve Ratio

An effective CRR offers many advantages. These include: 

  • CRR is helpful in sustaining and building the solvency position of any scheduled commercial bank.
  • CRR is primarily aimed at maintaining a consistent supply of cash and credit in the nation’s economy.
  • When the RBI reduces the CRR, scheduled commercial banks can offer more loans and other forms of credit, increasing the cash flow to borrowers. 
  • CRR acts as a good liquidity absorption instrument when the market interest rates fall. 
  • Implementing CRR is more effective when compared to the reliability of other monetary tools, such as Market Stabilisation Scheme bonds.
  • CRR plays a positive role in moderating the financial environment during a surplus cash situation.   

Cash Reserve Ratio Penalties

Banks maintain their CRR on a fortnightly basis. In case of default in maintaining the required CRR, banks are penalised by the RBI. And, if this continues for more than two fortnights, the concerned bank is prohibited from accepting fresh deposits. 

Banks maintain Statutory Liquidity Ratio (SLR) either in cash or gold, while CRR is maintained only in cash. The CRR and SLR jointly ensure the security of a customer’s deposits with the respective banks. 

Summing Up

Both CRR and SLR determine the condition of the economy and help you make informed decisions. You can use the prevailing CRR rate to decide whether the time is right to invest your funds, deposit them in a bank or borrow from the bank. CRR has many financial implications and a sound understanding of it will enable you to create the ideal investment portfolio.

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