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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 in the form of liquid cash.
This article covers the following:
The Cash Reserve Ratio acts 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). 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:
WWhen 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, certificate of deposits and investment in deposits 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 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 needs to pump funds into the system, it lowers CRR. which increases the loanable funds with the banks. The banks thus extend 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 & SLR are the 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 both cash 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.||The Central Bank controls the liquidity in the Banking system with 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 in 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 to the max to make higher profits and have very less 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. RBI curbs these issues with the help of the CRR.
While ensuring liquidity against deposits is the prime function of the CRR, it has an equally important role in controlling 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 availability of cash leads to the fall in rates while the scarcity of it leads to a sudden rise in rates, both of which are unhealthy for the economy.
Thus, as a depositor, it is good for you to know of the CRR prevailing in the market that 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 economy. RBI revises the repo rate and the reverse repo rate in accordance with the fluctuating macroeconomic factors. Whenever RBI modifies the rates, it impacts each sector of the economy; although in different ways. Some segments gain as a result of the rate hike while others may suffer losses. RBI recently cut down the repo rate by 25 basis points to 5.75% from 6%. In the same line, the reverse repo rate was also reduced by 25 basis points to 5.5% from 5.75%.
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 benchmark rate below which a bank/financial institution cannot lend.
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 soon as possible.