What is Cash Reserve Ratio (CRR)?

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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 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.

When the CRR increases, banks need to hold a higher proportion of their deposits in reserve, thus reducing the amount of money available for lending. This can lead to a decrease in credit availability, which in turn can slow down economic growth.

In contrast, when the CRR lowers, banks have more funds available to lend, thus leading to an increase in credit availability and potentially stimulating economic growth.

Considering that the CRR is 4.5%, then banks must keep aside Rs. 4.5 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 technical terms, the scheduled banks must ensure that their liquid cash held with the RBI on a bi-weekly basis does not dip below 4.5% of their total Net Demand and Time Liabilities (NDTL).

This figure of 4.5% may change and vary. 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.

Overall, the CRR has a significant impact on lenders and the broader economy by affecting the amount of credit available, the interest rates on loans, and the level of economic activity.

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. If the CRR rate increases, banks' ability to issue loans decreases, causing interest rates to rise.

CRR applies to Scheduled Commercial Banks (SCB) but not to Regional Rural Banks (RRB) or NBFCs.

CRR Impact on Economy

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 the current CRR rate?

The CRR is among the important components of the RBI’s monetary policy. As of 2023, the CRR rate is 4.5%, which has been effective since May 21, 2022.

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.
  • The Central Reserve Ratio (CRR) controls inflation by increasing to dissuade banks from lending more if inflation is high.
  • CRR is also linked to the base rate of loans, which is the rate below which banks cannot lend.
  • CRR helps control the supply of money in the economy. When CRR reduces, 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.

RBI can raise CRR to curb inflation, thus reducing the lending capacity of a bank. 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.

The public and other banks can describe NDTL as the bank's total demand and time liabilities (deposits) minus the deposits with other banks. The banks liabilities could take the form of:

  • Demand liabilities such as current deposits, Demand Drafts, cash certificates, etc.
  • Time liabilities such as FDs, gold deposits, cash certificates, etc
  • Other demand and time liabilities such as deposit interest, dividends, etc.

The formula used for calculating the cash reserve ratio is given below:

CRR(%)= Reserve Requirement / Deposits

Where CRR (cash reserve ratio) = the portion of the cash that the RBI asks respective commercial banks/financial institutes to keep aside and not use for lending or investment purposes.

NDTL = The difference between the sum of demand and time liabilities (deposits) of a bank/financial institute (with the public or the other bank/financial institute) and the deposits in the form of assets held by the other banks/financial institutes.

Deposit = The amount currently present with the banks/lenders

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. This means that it can regulate the CRR required from banks to control the flow of money in the economy from time to time. Since this objective is subject to the dynamics of the economy, and therefore, the cash reserve ratio will change periodically.

Difference between CRR and SLR

CRR or Cash Reserve Ratio and SLR or Statutory Liquid Ratio are both components of the RBI’s monetary policy. SLR defines the percentage of deposits a bank needs to keep as liquid assets. However, the RBI specifies that these funds are maintained not just in cash form, but also in gold, PSU bonds, government securities, and other assets.

CRR and SLR rate:

The rates as of June 8, 2022 are:

  • CRR = 4.5%
  • SLR = 18%

The key differences between CRR and SLR are as follows:

  • CRR includes cash reserves only, but SLR includes liquid assets such as gold, bonds, and securities as well.
  • Banks earn interest on the funds reserved as SLR, but no interest is earned on the funds reserved as CRR.
  • The RBI keeps CRR funds, but the bank itself holds SLR funds.

Now that you know what CRR is and have some insight into how it impacts lending, investments, and the economy at large, it is advisable to make well-informed financial choices.

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