crr

4th May 2022 – Reserve Bank of India (RBI) raised cash reserve ratio (CRR) by 50 basis points to 4.50% effectvie May 21.

Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with the latter as reserves in the form of liquid cash. Click here to know about SLR & Repo Rate.

Current cash reserve ratio is at 4%, this will be changed to 4.5% from May 21st.

Objectives of Cash Reserve Ratio

The Cash Reserve Ratio serves as one of the reference rates when determining the base rate. Base rate means the minimum lending rate below which a bank is not allowed to lend funds. The base rate is determined by the Reserve Bank of India (RBI).

The rate is fixed and ensures transparency with respect to borrowing and lending in the credit market. The Base Rate also helps the banks to cut down on their cost of lending to be able to extend affordable loans. Apart from this, there are two main objectives of the Cash Reserve Ratio: 

How does Cash Reserve Ratio work

When the RBI decides to increase the Cash Reserve Ratio, the amount of money that is available with the banks reduces. This is the RBI’s way of controlling the excess flow of money in the economy. The cash balance that is to be maintained by scheduled banks with the RBI should not be less than 4% of the total NDTL, which is the Net Demand and Time Liabilities. This is done on a fortnightly basis.

NDTL refers to the total demand and time liabilities (deposits) that are held by the banks. It includes deposits of the general public and the balances held by the bank with other banks. Demand deposits consist of all liabilities which the bank needs to pay on demand like current deposits, demand drafts, balances in overdue fixed deposits and demand liabilities portion of savings bank deposits.

Time deposits consist of deposits that need to be repaid on maturity and where the depositor can’t withdraw money immediately. Instead, he is required to wait for a certain time period to gain access to the funds. This includes fixed deposits, time liabilities portion of savings bank deposits and staff security deposits.

• Cash Reserve Ratio ensures that a part of the bank’s deposit is with the Central Bank and is hence, secure.
• Another objective of CRR is to keep inflation under control. During high inflation in the economy, RBI raises the CRR to reduce the amount of money left with banks to sanction loans. It squeezes the money flow in the economy, reducing investments and bringing down inflation.
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The liabilities of a bank include call money market borrowings, certificates of deposit and investment in deposits in other banks. In short, the higher the Cash Reserve Ratio, the lesser is the amount of money available to banks for lending and investing.

NDTL = Demand and time liabilities (deposits) with public sector banks and other banks – deposits with other banks (liabilities)

How does CRR affect the economy

Cash Reserve Ratio (CRR) is one of the main components of the RBI’s monetary policy, which is used to regulate the money supply, level of inflation and liquidity in the country. The higher the CRR, the lower is the liquidity with the banks and vice-versa. During high levels of inflation, attempts are made to reduce the flow of money in the economy.

For this, RBI increases the CRR, lowering the loanable funds available with the banks. This, in turn, slows down investment and reduces the supply of money in the economy. As a result, the growth of the economy is negatively impacted. However, this also helps bring down inflation.

On the other hand, when the RBI wants to pump funds into the system, it lowers the CRR, which increases the loanable funds with the banks. The banks in turn sanction a large number of loans to businesses and industry for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.