CRR or Cash Reserve Ratio, 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 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.
Why is CRR higher than SLR?
CRR is typically higher than SLR because it directly controls the money available for lending and helps manage liquidity in the banking system. SLR serves as an additional safeguard for banks' liquidity and solvency. Both ratios are tools used by the central bank to influence the money supply and ensure the stability of the banking system.
What is CRR and how does CRR impact 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.
The impact of CRR on the economy can be summarized as follows:
- Money Supply: By adjusting the CRR, the central bank can influence the money supply in the economy. Increasing the CRR reduces the funds available with commercial banks for lending, leading to a contraction in the money supply. Conversely, decreasing the CRR increases the lendable resources of banks, resulting in an expansion of the money supply.
- Inflation Control: One of the primary objectives of implementing a CRR is to control inflation. When inflation is high, the central bank may raise the CRR to reduce the liquidity in the banking system and curb excessive lending. This helps in controlling inflationary pressures by limiting the amount of money available for spending.
- Interest Rates: Changes in the CRR can indirectly impact interest rates. Increasing the CRR reduces the lendable resources of banks, which may lead to a scarcity of funds. This can push up interest rates as banks lend at higher rates to manage their reduced liquidity. Conversely, a decrease in the CRR can increase the lendable resources, potentially leading to lower interest rates.
- Bank Profitability: The CRR requirement affects the profitability of commercial banks. Since the funds kept as cash reserves with the central bank do not earn interest, banks have to forgo potential earnings on those funds. Higher CRR requirements can reduce the profitability of banks, while lower CRR requirements can increase their profitability.
- Credit Availability: Changes in the CRR can impact the availability of credit in the economy. When the CRR is high, banks have limited funds available for lending, which can result in reduced credit availability and tighter lending standards. Conversely, a lower CRR can increase the availability of credit as banks have more funds to lend.
It's important to note that the impact of CRR on the economy depends on various factors, including the prevailing economic conditions, monetary policy goals, and the effectiveness of other policy tools used in conjunction with the CRR. Central banks carefully assess these factors to make informed decisions regarding changes in the CRR to achieve their monetary policy objectives.
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.
The Cash Reserve Ratio (CRR) is a monetary policy tool used by central banks to regulate the money supply and control inflation. Here's how CRR works:
- CRR is the percentage of a bank's net demand and time liabilities (NDTL) that it is required to maintain as cash reserves with the central bank. NDTL includes deposits and certain other liabilities of commercial banks.
- Mandatory Reserves: When the central bank imposes a CRR requirement, it specifies the percentage of NDTL that banks must keep as cash reserves. For example, if the CRR is set at 4%, a bank with NDTL of ₹100 crore must maintain ₹4 crore (4% of ₹100 crore) as cash reserves.
- Reserve Maintenance: Banks are required to maintain their cash reserves on a daily basis, as prescribed by the central bank. This reserve maintenance is usually done through an account called the Cash Reserve Ratio account, held by the central bank. Banks transfer the required amount from their own funds to this account.
- Purpose and Impact: The primary objective of CRR is to control the money supply in the economy. By keeping a portion of their deposits as cash reserves, banks have fewer funds available for lending and investment purposes. This helps in curbing excessive lending and potential inflationary pressures.
- Liquidity Management: CRR also serves as a liquidity management tool for the central bank. By adjusting the CRR requirement, the central bank can influence the liquidity position of banks. Increasing the CRR reduces the lendable resources of banks, thereby draining liquidity from the system. Conversely, decreasing the CRR injects liquidity into the banking system.
- Monetary Policy Tool: Central banks use changes in the CRR as part of their monetary policy framework. They may increase the CRR to tighten monetary conditions and control inflation, or decrease it to ease liquidity and stimulate economic growth.
- Implications for Banks: Maintaining cash reserves reduces the profitability of banks since those funds do not earn interest. Banks have to forgo potential earnings on the funds held as cash reserves. Changes in the CRR can impact the profitability and lending capacity of banks.
- Statutory Requirement: CRR is typically a statutory requirement, meaning banks are legally obligated to maintain the specified percentage of their NDTL as cash reserves. Non-compliance with the CRR requirement may lead to penalties or other regulatory actions.
Overall, the Cash Reserve Ratio acts as a tool for the central bank to regulate liquidity in the banking system, influence lending capacity, and manage inflationary pressures. It is an important component of a central bank's monetary policy toolkit.
Changing the Cash Reserve Ratio (CRR) can impact home loans indirectly. When the CRR is increased, it can lead to higher interest rates on home loan and reduced availability of credit. This happens because banks have to hold more of their deposits in reserves, limiting their lending capacity. Additionally, changes in the CRR are part of broader monetary policy efforts by central banks to control inflation and stabilize the economy, which can affect the overall demand for housing and home loans. Borrowers and lenders should be aware of these potential impacts on the cost and availability of home loans.