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A government may intervene in the financial affairs of its country from time to time to regulate the economy and prevent economic extremities of any kind. To do so, the government may have regulatory tools and procedures with important financial bodies like banks. CRR (Cash Reserve Ratio) is one of the tools the government uses to exercise control over the economy.
Let’s delve into the details of CRR – its purpose and impact on the economy.
What is CRR?
CRR’s full form is Cash Reserve Ratio. Every bank has deposits from its customers and it is statutorily required by the Reserve Bank of India (RBI) to maintain a certain percentage of these deposits as cash with the RBI.
The CRR is a rate that is announced by the RBI, determining the percentage of deposits that banks need to maintain as cash. Here, the cash reserve is deposited to the RBI. These deposits can not be utilised for lending, investment, or other purposes. The current CRR is 4.5%.
Purpose of CRR
CRR rate mainly serves two purposes:
- Safety: CRR acts as a safety blanket against sudden liquidity crunches or other emergencies. Since the RBI does not invest the funds anywhere and is readily available, it is a secure reserve for banks.
- Tool to control money supply in the economy: CRR is an essential tool in the government’s monetary policy toolkit. The level of money supply available in the economy is controlled using monetary policy.
How do banks maintain a cash reserve ratio in India?
Every bank has a cash reserve ratio account that they maintain with the RBI and replenish with cash as required.
The bank calculates the requirement as a percentage of its Net Demand and Time Liabilities (NDTL). NDTL comprises various deposits, such as fixed deposits, savings bank deposits, recurring deposits, and others.
For instance, if a bank has ₹1,000 crores of NDTL and the CRR is at 4.50%, then the bank is obligated to deposit at least ₹45 crores with the RBI.
How does the CRR affect the economy?
Let us understand this with the help of an example.
Consider a situation where inflation is high in the economy. In July 2023, India’s retail inflation surged to a 15-month high of 7.44% from 4.81% in June 2023. In this situation, the government will want to reduce the amount of money in the hands of people so that spending goes down. A fall in demand will follow this, which will lead to a fall in the prices of goods and services, i.e. lower inflation.
To reduce liquidity in the economy, the best way is to target the citizens’ source of liquidity, i.e. banks. When the CRR increases, the banks will be required to deposit a higher percentage of their deposits with the RBI for safekeeping.
This means the bank has a relatively lower amount of money to lend to customers. Lower funds mean banks must increase lending rates, causing fewer borrowers. This eventually translates into lower liquidity in the economy and has the desired effect of reduced inflation.
Similarly, if the government wants to boost spending, it will reduce the CRR, eventually increasing the level of demand.
CRR and SLR differences
Statutory Liquid Ratio (SLR), like CRR, is another monetary policy tool that the government deploys through banks.
| Point of Difference | Cash Reserve ratio | Statutory Liquid Ratio |
| Meaning | The CRR is a rate that is announced by the RBI and determines the percentage of bank deposits that need to be maintained as cash with the RBI. | The SLR is a rate declared by the RBI which entails the minimum percentage of deposits that a bank must maintain with itself in the form of liquid assets like cash, gold and other RBI-approved securities. |
| Interest Earned | The banks do not earn any interest on the amount that they deposit in their CRR account. | The banks earn interest on their SLR deposits. |
| Purpose | Mainly to control the level of liquidity and as a safe reserve held with the RBI. | To control the level of liquidity, leverage credit expansion and ensure the solvency of banks. |
| Current Rate | 4.50% | 18.00% |
| Deposited With | The RBI | The bank itself |
Bottom line
In short, the cash reserve ratio is the minimum amount of cash banks are statutorily required to maintain with the central bank. It is an important monetary policy tool for the government.
FAQs
The Cash Reserve Ratio (CRR) is maintained by banks to ensure they have a mandatory amount of funds available as liquid cash. This is to secure against sudden large withdrawals and to provide the central bank, such as the Reserve Bank of India (RBI), with a tool to control the money supply within the economy. By adjusting the CRR, the RBI can influence lending and borrowing rates, thereby managing liquidity and inflation.
CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) are regulatory measures that banks must adhere to. CRR is the percentage of a bank’s total deposits that must be kept in cash with the RBI, serving as a reserve to manage liquidity. SLR is the percentage of deposits that banks must maintain in liquid assets like cash, gold, and government securities, ensuring the bank’s solvency and controlling credit expansion2.
The repo rate is the rate at which the RBI lends money to commercial banks, usually for short-term purposes, against government securities. Conversely, the reverse repo rate is the rate at which the RBI borrows money from commercial banks. These rates are pivotal in managing the liquidity in the banking system, influencing the flow of money and overall economic stability.
Maintaining CRR and SLR is crucial for the stability of the banking system. CRR ensures that a portion of bank deposits is available as liquid cash with the RBI, which helps in controlling the money supply. SLR requires banks to hold a certain percentage of their deposits in liquid assets, ensuring they have sufficient funds to meet their obligations and maintain solvency. These ratios are tools used by the RBI to regulate the economy and manage inflation
Non-Performing Assets (NPAs) in banking refer to loans or advances that have become non-productive due to the borrower’s failure to make principal and interest payments for a period of 90 days or more. NPAs are a concern for banks as they affect the lender’s income and profitability, reduce the capacity to lend, and increase the risk of defaults and write-offs.