What is CRR and How Does it Impact Lenders and the Economy?
Cash reserve ratio or CRR is a part of the RBI’s monetary policy, which helps eliminate liquidity risk and regulate money supply in the economy. In case the CRR rate is increased, the ease in which banks can issue loans decreases and hence, interest rates increase. CRR applies to Scheduled Commercial Banks (SCB) but not to Regional Rural Banks (RRB) or NBFCs.
As a borrower, CRR has an indirect bearing on your dealings with financial institutions. So, it is worth knowing what is CRR and how it impacts lenders and the economy. Read on to know more about CRR.
What is Cash Reserve Ratio (CRR)?
Cash reserve ratio (CRR) is the percentage of a bank’s total deposits that it needs to maintain as liquid cash. This is an RBI requirement, and the cash reserve is kept with the RBI. A bank does not earn interest on this liquid cash maintained with the RBI and neither can it use this for investing and lending purposes.
Consider that the CRR is 4%. If so, banks must keep aside Rs.4 every time their deposits raise by Rs.100. The equation is very simple, but the implications of CRR on the economy at large are many. In more technical terms, here, the liquid cash that scheduled banks need to maintain with the RBI on a fortnightly basis must not fall short of 4% of the total Net Demand and Time Liabilities (NDTL) that the bank holds.
This figure of 4% may change and vary. In the past, CRR used to range between 3% and 20%. However, today, there is no upper and lower limit on the CRR for scheduled banks. To understand the concept of CRR clearly, consider this example: if a bank has net demand and time deposits worth Rs.10,00,000 and the CRR is 8%, it will have to keep Rs.8,00,000 with the RBI in the form of liquid cash.
What is the Current CRR rate?
The CRR is among the important components of the RBI’s monetary policy and the current CRR rate stands at 3%. Considering that previously, the lower limit for the CRR rate was 3%, you can think of the current rate as being low.
What is CRR in relation to the economy? This question is important as CRR is not just an isolated figure, but one that helps the RBI direct the economy. The next section provides insight.
What are the Objectives of Cash Reserve Ratio?
There are a handful of important reasons for CRR to exist.
- CRR ensures that banks always maintain a minimum level of liquidity. This way funds are easily available to customers, even if there is huge demand.
- Another way of saying it is that since the RBI holds part of the bank’s deposit, that portion, as defined by the CRR, remains secure.
- CRR helps control inflation. If inflation is high, CRR can be increased to dissuade banks from lending more.
- CRR is also linked to the base rate of loans, which is the rate below which banks cannot lend. Base rate ensures transparency in lending and CRR serves as a reference rate for it.
- CRR helps control the supply of money in the economy. When CRR is reduced it has a positive effect on the economy.
How does CRR Control Inflation?
CRR affects the level of liquidity in the country’s economy and as such, has a direct bearing on inflation. You can think of CRR as one of the faucets the RBI has to control the supply of money in the economy.
If inflation is high and the supply of money is pushing it higher, the RBI can decide to turn up the CRR requirement and thereby reduce the capacity of banks to lend. With less loans there is less money flowing through the economy and less pressure on inflation.
How is CRR Calculated?
CRR is calculated as a percentage of the bank’s NDTL, that is, net demand and time liabilities.
NDTL in turn can be described as the bank’s total demand and time liabilities (deposits) with the public or other banks minus the deposits with other banks.
The banks liabilities could take the form of:
- Demand liabilities such as current deposits, DDs, cash certificates, etc.
- Time liabilities such as FDs, gold deposits, cash certificates, etc.
- Other demand and time liabilities such as deposit interest, dividends, etc.
A simple formula for CRR would be:
CRR = (Liquid cash/ NDTL)*100
Why Does the Cash Reserve Ratio Keep on Changing?
CRR serves as a safety net for customers, ensuring that banks have enough liquidity to handle a surge in demand for funds through withdrawals. Beyond that, the RBI is free to meet its other objectives and slash or increase the CRR, meaning that it can, from time to time, regulate the CRR required from banks to better control the flow of money in the economy. Since this objective is one that is subject to the dynamics of the economy, and therefore, to change, the cash reserve ratio is bound to go up or down periodically.
Difference Between CRR and SLR
CRR and SLR are both components of the RBI’s monetary policy and while the CRR full form is Cash Reserve Ratio, SLR stands for Statutory Liquid Ratio. SLR describes the percentage of deposits a bank needs to keep as liquid assets, however, here, these funds are maintained not just in the form of cash, but gold, PSU bonds, government securities, and any asset specified by the RBI.
CRR and SLR rate 2020: The CRR and SLR have been revised a few times in 2020. The current rates as of November 2020 are:
- CRR = 3%
- SLR = 18.50%
The key differences between CRR and SLR can be summarised as:
- CRR includes cash reserves only, but SLR includes liquid assets such as gold, bonds, and securities as well.
- No interest is earned on the funds reserved as CRR, but banks earn on SLR.
- CRR funds are kept with the RBI, but SLR funds are kept with the bank itself.
Now that you know what is CRR and have some insight into how it impacts lending, investments, and the economy at large, proceed to make informed financial decisions!
