Cash Reserve Ratio (CRR) is a specified minimum amount of deposit that the commercial bank has to hold as a reserve with the Central Bank. The amount specified as CRR is maintained as a reserve in the form of cash or cash equivalent and is either stored in the bank’s vault or sent to the Central Bank. CRR is determined as per the guidelines of the Central Bank of a country.
CRR deposits ensure that banks do not run out of money. Banks cannot lend CRR deposits to corporates or individual borrowers. Also, banks cannot use CRR money for investment purposes, as banks do not earn any margin on that money. CRR gives greater control to the Central Bank over the money supply. When a Central Bank raises the CRR, the amount of money accessible to banks reduces and vice-versa.
In India, the CRR is the minimum percentage of total deposits that a commercial bank is required to retain as cash reserves with the Reserve Bank of India (RBI). It is the portion of the bank deposits that a bank should keep with the RBI in cash form. The cash reserve is either stored in the bank’s vault or sent to the RBI. In simple terms, CRR is the cash deposit a bank maintains with the RBI. CRR is governed by the provisions of Section 42 of the Reserve Bank of India Act of 1934. Every commercial bank is obligated to maintain CRR, which is a specified percentage of their net demand and time liabilities (NDTL).
Significance of CRR
CRR is used for liquidity management and is a monetary tool to regulate the money supply in an economy. One of the main aims of CRR is to remove excess cash from the economy.
The bank has to retain a certain percentage of its demand and time liabilities in cash with the RBI, which the RBI can raise to drain out excess liquidity or reduce to release liquidity in the economy.
CRR plays a significant role in regulating the level of inflation in the economy. During high inflation, the Reserve Bank of India (RBI) increases the CRR rate to reduce the amount of money that is available with the banks, thus reducing the excess flow of money in the economy.
Also, the high CRR rate can negatively impact the economy, as lesser availability of credit funds, in turn, slow down investment. Therefore, the supply of money or liquidity in the economy will reduce.
CRR deposits earn no interest. The more the CRR, the less money is available for lending by the banks to customers. During the need for funds, the government can lower the CRR rate to help the banks to provide loans to various businesses and industries for investment. A low CRR rate also increases the growth rate of the economy.
CRR ensures that banks do not run out of cash to meet their depositors’ payment demands. RBI, which holds a portion of the bank’s deposit, assures that money is safe. It makes it simple for the customers to get their deposits refunded.
Who determines CRR in India?
The Cash Reserve Ratio (CRR) in India is determined by the RBI’s six-member Monetary Policy Committee (MPC) under the periodic Monetary and Credit Policy in every monetary policy review.
The percentage of cash required to be kept in reserves, vis-a-vis a bank’s total deposits, is called Cash Reserve Ratio. CRR is computed as a percentage of the net demand and time liabilities of each bank. Net Demand and Time Liabilities (NDTL) is reached with the total of the saving accounts, current account, and fixed deposit balances.
CRR will help the RBI in its role as a regulator. CRR is one of the RBI’s monetary tools, which allows it to maintain a required level of inflation and control the money supply and liquidity in the economy.
When there is high inflation in the economy, the RBI increases the CRR, forcing banks to maintain more money in reserves, thus reducing their ability to lend.
When the RBI reduces the CRR, commercial banks have the capacity to offer more loans and other forms of credit to borrowers, which in turn, will raise the flow of cash to the public.
When market interest rates drop significantly, RBI then increases the CRR and soaks-up money supply from circulation, which helps in improving the declining interest rates.