Cash Reserve Ratio (CRR) – Meaning, Objective, Significance, & Effect

Get to know About Cash Reserve Ratio: CRR (Objective, Significance, Effect): The Reserve Bank of India (RBI) is in charge of supervising banking operations in India and implements various measures to manage money circulation in connection with the economic scenario. One of the important tools of the RBI’s monetary policy is the cash reserve ratio or CRR. All commercial banks need to abide by the guidelines regarding CRR as devised by the RBI.

In this article, we will discuss in detail the cash reserve ratio (CRR), including its definition and justification. Also, find out its objectives, significance, and how it is calculated.

Cash Reserve Ratio

What is the Cash Reserve Ratio?

The cash reserve ratio is the portion of cash that banks are required to maintain as deposits with the RBI. The RBI sets this proportion, which is periodically modified by the central bank itself. The amount designated as the cash reserve ratio is kept with the RBI in the form of cash. The goal of CRR is to make sure banks have enough cash on hand to cover depositors’ demands for payments.

Why Do Banks Need to Maintain Cash Reserve Ratio?

The overall liquidity is thoroughly managed and administered when all the commercial banks maintain the required CRR rate, which is beneficial to each bank. If the CRR rate for the amount maintained with the RBI is high, the economy’s liquidity will be low. Conversely, if the CRR reserved with the RBI is low, the economy’s overall liquidity will be higher. Keeping the specified cash reserve ratio helps banks hold the appropriate amount of funds with them and never fall short of money to meet customers’ demands.

Objectives of the Cash Reserve Ratio

The objectives of implementing the Cash Reserve Ratio (CRR) are as follows:

• The CRR helps keep inflation under control. The RBI can increase the CRR to discourage banks from making more loans when there is a risk of inflation.
• Even during periods of strong demand, CRR guarantees that banks maintain a certain amount of money accessible to consumers.
• The reference rate for the loan is the CRR. Lending rates cannot be lowered by banks from their base lending rate.
• Because the CRR controls the amount of money in circulation, it can contribute to boosting the economy.

Significance of the Cash Reserve Ratio

The primary goal of the cash reserve ratio is to ensure that the bank has enough liquid cash on hand to cover depositors’ needs and avoid running out of money. Here is its significance.

• CRR aids in the distribution of money across the economy. The RBI raises the CRR to control surplus funds in response to an increase in the money supply. Similarly, the RBI lowers the CRR rate to release more money into the market in the event of a liquidity crunch.
• It guarantees that every commercial bank has a uniform and well-maintained mechanism to maintain liquidity.
• The RBI is able to oversee and coordinate the credit held by banks through the CRR rate, which regulates the flow of credit and cash into the economy.
• With a higher cash reserve ratio, banks have less money available that can be used for lending and investment.
• With lower CRR rates, commercial banks can provide borrowers with higher advances, which boosts the flow of cash to the general population.
• The CRR affects interest rates since there is a direct relationship between the money supply and interest rates in the economy.

How is the Cash reserve ratio calculated?

There is no specific formula for calculating the cash reserve ratio. CRR is determined as a proportion of NDTL, or net demand and time liabilities. In terms of banking, NDTL is the total amount of money that a bank has in its current account, savings account, and fixed deposit accounts. Therefore, as per guidelines for the cash reserve ratio, a certain percentage of the total balances in all three of these categories must be maintained with the RBI. Let’s look into the meaning of each component of NDTL.

Demand Deposits: All obligations that the bank must pay on demand, such as current deposits, demand drafts, balances due in fixed deposits, and the demand liabilities portion of savings bank deposits.

Time Deposits: These are the funds that have an immediate withdrawal restriction and must be returned at maturity after a certain time.

Liabilities: A bank’s market borrowings, certificates of deposit, and investments in deposits held by other banks are examples of its liabilities.

NDTL is equal to demand and time liabilities (deposits) with other banks and public sector banks minus deposits (liabilities) with other banks.

Effect of the Cash Reserve Ratio

The cash reserve ratio is one of the key elements of the RBI’s monetary policy, which controls the nation’s money supply, rate of inflation, and liquidity. Liquidity with the banks decreases as the CRR rises, and vice versa. CRR makes an impact on the money circulation, which in turn addresses the problem of inflation.

The RBI increases the CRR, which means lower amounts of funds are available to banks for lending purposes. Consequently, the economy experiences a decrease in money supply and a slowdown in investment. This might have a detrimental effect on the economy’s growth, but it also contributes to a decrease in inflation.

Conversely, when the RBI wishes to add money to the system, it decreases the CRR, which raises the amount of money that banks can lend out. In turn, the banks authorize a significant volume of loans to companies and the industry for various investment purposes. Additionally, it expands the economy’s total money supply. In the end, this accelerates the rate of economic growth.

What is the Cash Reserve Ratio Changed Regularly?

Banks generate revenues through lending, and to do this, they can lend the largest amount possible in order to increase profits and have very little cash on hand. In the event that there is a sudden demand from customers to withdraw large amounts of money, banks will fail to meet the customer’s requirements for payback.

The RBI manages the economy through short-term modifications in the cash reserve ratio from time to time. To control the system’s liquidity supply in an economy with an excess of cash, the RBI raises CRR rates to combat inflation. Again, to address challenges with a shortage of cash, the RBI lowers CRR rates to promote economic growth.

Conclusion – Get to know About Cash Reserve Ratio: CRR (Objective, Significance, Effect)

In conclusion, the objective of CRR is to ensure that a specific percentage of all deposits in banks are always kept secure with the RBI. The CRR serves as a tool to protect the major liquidity of deposits. In the same process, it also contributes toward regulating inflation rates across the economy. In the above article, we have provided complete detail about the significance and impact of the Cash Reserve Ratio.

FAQs on Cash Reserve Ratio –

What is the primary objective of the cash reserve ratio?

The cash reserve ratio fixed by the RBI intends to ensure the economy’s smooth running and the safety of its customers. It makes sure banks have adequate money to cover their clients’ requirements, particularly when there are a lot of withdrawals.

What is the current cash reserve ratio as fixed by the RBI?

The RBI has fixed a 4.5% cash reserve ratio to be maintained by banks.

In what way does SLR differ from CRR?

The Statutory Liquidity Ratio (SLR) refers to the percentage of deposits to be maintained by banks with RBI that can be gold, cash, or other securities. On the other hand, the cash reserve ratio (CRR) is the percentage of a bank’s deposits to be held with the RBI in the form of cash.

How does the CRR control the rate of inflation?

The RBI may increase the Cash Reserve Ratio in the event of higher inflation in an effort to reduce banks’ ability to lend money and consequently cut inflation.

What happens when the cash reserve ratio rises?

An increase in the CRR lowers the money supply, drives up interest rates on loan products, and boosts money market demand between banks, which in turn lowers inflation.