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Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with the latter as reserves in the form of liquid cash. Click here to know about SLR & Repo Rate.
The Cash Reserve Ratio serves as one of the reference rates when determining the base rate. Base rate means the minimum lending rate below which a bank is not allowed to lend funds. The base rate is determined by the Reserve Bank of India (RBI).
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The rate is fixed and ensures transparency with respect to borrowing and lending in the credit market. The Base Rate also helps the banks to cut down on their cost of lending to be able to extend affordable loans. Apart from this, there are two main objectives of the Cash Reserve Ratio:
When the RBI decides to increase the Cash Reserve Ratio, the amount of money that is available with the banks reduces. This is the RBI’s way of controlling the excess flow of money in the economy. The cash balance that is to be maintained by scheduled banks with the RBI should not be less than 4% of the total NDTL, which is the Net Demand and Time Liabilities. This is done on a fortnightly basis.
NDTL refers to the total demand and time liabilities (deposits) that are held by the banks. It includes deposits of the general public and the balances held by the bank with other banks. Demand deposits consist of all liabilities which the bank needs to pay on demand like current deposits, demand drafts, balances in overdue fixed deposits and demand liabilities portion of savings bank deposits.
Time deposits consist of deposits that need to be repaid on maturity and where the depositor can’t withdraw money immediately. Instead, he is required to wait for a certain time period to gain access to the funds. This includes fixed deposits, time liabilities portion of savings bank deposits and staff security deposits.
The liabilities of a bank include call money market borrowings, certificates of deposit and investment in deposits in other banks. In short, the higher the Cash Reserve Ratio, the lesser is the amount of money available to banks for lending and investing.
NDTL = Demand and time liabilities (deposits) with public sector banks and other banks – deposits with other banks (liabilities)
Cash Reserve Ratio (CRR) is one of the main components of the RBI’s monetary policy, which is used to regulate the money supply, level of inflation and liquidity in the country. The higher the CRR, the lower is the liquidity with the banks and vice-versa. During high levels of inflation, attempts are made to reduce the flow of money in the economy.
For this, RBI increases the CRR, lowering the loanable funds available with the banks. This, in turn, slows down investment and reduces the supply of money in the economy. As a result, the growth of the economy is negatively impacted. However, this also helps bring down inflation.
On the other hand, when the RBI wants to pump funds into the system, it lowers the CRR, which increases the loanable funds with the banks. The banks in turn sanction a large number of loans to businesses and industry for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.
Both CRR and SLR are the essential components of the monetary policy. However, there are a few differences between them. The following table gives a glimpse into the dissimilarities:
Statutory Liquidity Ratio (SLR)
Cash Reserve Ratio (CRR)
In the case of SLR, banks are asked to have reserves of liquid assets, which include cash, government securities and gold.
The CRR requires banks to have only cash reserves with the RBI
Banks earn returns on money parked as SLR
Banks don’t earn returns on money parked as CRR
SLR is used to control the bank’s leverage for credit expansion. It ensures the solvency of banks
The Central Bank controls the liquidity in the Banking system through CRR
In the case of SLR, the securities are kept with the banks themselves, which they need to maintain in the form of liquid assets.
In CRR, the cash reserve is maintained by the banks with the Reserve Bank of India
As per the RBI guidelines, every bank is required to maintain a ratio of their total deposits that can also be held with currency chests. This is considered to be the same as it is kept with the RBI. The RBI can change this ratio from time to time at regular intervals. When this ratio is changed, it impacts the economy.
For banks, profits are made by lending. In pursuit of this goal, banks may lend out maximum amounts, to make higher profits and have very little cash with them. An unexpected rush by customers to withdraw their deposits will lead to banks being unable to meet all the repayment needs.
Therefore, CRR is vital to ensure that there is always a certain fraction of all the deposits in every bank, kept safe with them. While ensuring liquidity against deposits is the prime function of the CRR, it has an equally important role in controlling the interest rates in the economy.
The RBI controls the short-term volatility in the interest rates by adjusting the amount of liquidity available in the system. Too much cash in the economy leads to the RBI raising interest rates to bring down inflation, while the scarcity of cash leads to the RBI cutting interest rates, to stimulate growth in the economy.
Thus, as a depositor, it is good for you to know of the CRR prevailing in the market. It ensures that regardless of the performance of the bank, a certain percentage of your cash is safe with the RBI.
Apart from CRR, there are other metrics used by RBI to regulate the money supply in the economy. RBI revises the repo rate and the reverse repo rate in accordance with the fluctuating macroeconomic conditions. Whenever RBI modifies the rates, it impacts each sector of the economy; albeit in different ways.
Changes in the repo rates can directly impact big-ticket loans such as home loans. An increase/decrease in the repo rates can result in banks and financial institutions revising their MCLR proportionately. The MCLR (Marginal Cost of Funds Based Lending Rate) is the internal reference rate that helps banks find out the interest they can levy on loans.
A decline in the repo rate can lead to the banks bringing down their lending rate. This can prove to be beneficial for retail loan borrowers. However, to bring down the loan EMIs, the lender has to reduce its base lending rate. As per the RBI guidelines, banks/financial institutions are required to transfer the benefit of interest rate cuts to consumers as fast as possible.