Introduction
Cash reserve ratio (CRR) is the amount of money that the scheduled banks will have to have in deposit with the central bank of the country at all times. If the central bank increases the CRR, then the scheduled banks will have a lesser amount available in their disposal. CRR is the amount that the bank has, which cannot be invested anywhere or given as loans to the borrowers.
Importance of CRR
CRR is one of the most important tools for the Reserve Bank of India (RBI) and is used mostly in controlling inflation/deflation and liquidity in the economy. RBI is the supreme banking body in India and has all the rights to modify the CRR at any given time.
CRR and Liquidity
The cash reserve ratio is particularly useful in dealing with the rate of inflation/deflation and liquidity in the country. If the central bank is of the opinion that there is too much liquidity in the economy, it will increase the CRR. This reduces the banks’ lending ability as they would be left with a lesser amount which can be used to issue loans and make investments.
When this happens, the spending would be reduced and thereby liquidity and inflation in the economy drops. If the central bank sees that there is a liquidity crunch, then it would reduce the CRR. This move would leave banks with more money at disposal. This will result in the appreciation of the banks’ lending power, and thereby, more borrowers can avail loans.
It will help in inflating the prices to some extent as people would have more money in their hand for spending. Therefore, CRR is an extremely powerful tool in the hands of RBI, which can dictate the terms in the economy.
