What is Cash Reserve Ratio (CRR)?

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The Cash Reserve Ratio (CRR) is a monetary policy tool used by the Reserve Bank of India (RBI) to regulate the liquidity and solvency of scheduled commercial banks in the country. The Cash Reserve Ratio (CRR) is a mandatory reserve requirement set by the Reserve Bank of India (RBI) for commercial banks in India. It dictates the minimum portion of a bank’s Net Demand and Time Liabilities (NDTL) that must be maintained as cash deposits with the RBI. This serves two key purposes:

  • Ensures Liquidity and Solvency: By holding a portion of deposits as reserves, banks can meet withdrawal demands from customers and maintain their financial stability.
  • Controls Money Supply: The CRR acts as a tool for the RBI to regulate the amount of money circulating in the economy.

Key Points

  • CRR refers to the percentage of a bank’s net demand and time liabilities (NDTL) that it must maintain as cash reserves with the RBI.
  • It ensures that banks hold a certain portion of their deposits in cash to meet depositor withdrawals and other obligations.
  • Banks do not earn any interest on the amount held as CRR with the RBI.

Impact of CRR:

  • Increase in CRR: When the RBI increases the CRR, it reduces the amount of funds available for banks to lend. This can help control inflation by dampening overall demand in the economy. However, it can also restrict economic growth by limiting credit availability.
  • Decrease in CRR: Conversely, a decrease in CRR allows banks to lend a larger portion of their deposits, potentially stimulating economic activity by increasing the money supply. However, it can also increase inflationary pressures if not managed effectively.

Example of CRR Impact: Scenario of Inflation Control:

  • Suppose there are inflationary trends in the economy prompting the RBI to take action.
  • If the RBI increases SLR (Statutory Liquidity Ratio) to 50% and CRR to 20%, banks would need to maintain a larger portion of their deposits as reserves.
  • For instance, if a bank has ₹2 billion of NDTL, it would have to keep ₹400 million (20% of NDTL) as cash reserves with the RBI.
  • This reduces the amount of funds available for the bank to lend or invest, potentially impacting profitability.
  • To compensate for reduced liquidity, the bank might raise interest rates on loans, making borrowing costlier for customers.
  • Higher interest rates tend to reduce overall demand in the economy, leading to a moderation in prices over time.