Updated Feb 01, 2022

What is the Cash Reserve Ratio (CRR)?

What is the Cash Reserve Ratio (CRR)?

 

 

In India, the Monetary Policy Committee of the Reserve Bank of India decides on the Cash Reserve Ratio in its monthly Monetary and Credit Policy. Every six weeks, the Reserve Bank of India conducts a monetary policy review, which includes a review of the CRR. The CRR is one of the RBI's main weapons for maintaining a desirable level of inflation, controlling the money supply, and ensuring liquidity in the economy. The lower the CRR, the more liquidity there is in the banking system, which leads to increased investment and lending, and vice versa. Higher CRR can have a negative influence on the economy since it reduces the availability of loanable money, which slows investment. As a result, the economy's money supply is reduced.

 

 

What is CRR or Cash Reserve Ratio?

 

The Reserve Bank of India (RBI) requires banks to keep a percentage of their deposits in cash so that they can be provided to clients in an emergency. The Cash Reserve Ratio is the percentage of cash that must be retained in reserves about a bank's total deposits. Either the cash reserve is held in the bank's vault or it is delivered to the Reserve Bank of India. Banks do not get interested in money held by the RBI under the CRR laws.

 

 

CRR's Objectives

 

When it comes to regulating the Base Rate, the Cash Reserve Ratio, or CRR, is one of the reference rates. The Reserve Bank of India sets and determines the base rate, which is the lowest lending rate available (RBI). It should be emphasized that no bank is allowed to lend money at a rate lower than this.

The Base Rate has been set at a precise predetermined number to ensure the transparency of lending and borrowing in the credit market. It also aids banks in lowering their loan costs. As a result, banks would be able to offer more reasonable loans.

 

As a result, the Cash Reserve Ratio's primary goals are as follows:

 

• The Cash Reserve Ratio guarantees that a portion of the bank's deposit is held by the Central Bank. As a result, some of the deposit is secure.
• Another goal of the CRR is to keep inflation stable and under control. During periods of high inflation, the RBI raises the CRR to reduce the bank's loanable funds.

 

 

In periods of high inflation, how can the Cash Reserve Ratio help?

 

When there is excessive inflation, the government must ensure that there is no extra money in the economy. As a result, the Reserve Bank of India raises the Cash Reserve Ratio, reducing the amount of money available to banks. This reduces the amount of money flowing into the economy. The CRR rate is dropped when the government has to infuse capital into the system, allowing banks to lend to a larger number of businesses and industries for investment purposes. Lowering the CRR boosts the economy's growth rate as well.

 

 

How does the CRR Working?

 

When the RBI decided to raise the value of the Cash Reserve Ratio, the amount of money accessible to banks would decrease (CRR). The Reserve Bank of India can control the excess supply of money in the economy in this way. The Reserve Bank of India has ordered that scheduled banks maintain a cash balance with the latter. The cash balance, on the other hand, should not go below 4% of total Net Demand and Time Liabilities (NDTL). This would be done every two weeks by the Central Bank.

 

The primary goal of any bank is to make loans. They would profit by maximizing their lending capacity, which is accomplished through loan sanctioning. Banks obtain funds from their customers in the form of deposits for this reason. Customers who frequently bring in healthy deposits are offered deposit plans by these banks. Then, in general, they lend the same money to their borrowers at a much higher rate of interest than what is offered for deposits. The difference between the rates of interest on loans and deposits is the profit earned by a bank.

 

CRR is used to ensure that the bank does not run out of funds if a customer requests their money back. Every commercial bank accepts deposits from customers for a set period in exchange for agreeing to pay a specific interest rate on the cash. These deposits are frequently utilized to make numerous loans. As a result, CRR refers to the percentage of deposits that each commercial bank is required to hold as a reserve with the Central Bank. The bank cannot utilize the funds it has set aside with the RBI for any other purpose, including lending. The Cash Reserve Ratio's principal goal is to ensure that banks never run out of cash and can quickly make payments of amounts demanded by depositors.

 

 

CRR's Importance

 

The reasons why CRR is regarded as a critical and regulatory feature for every commercial bank are as follows.

 

• The CRR is an important monetary policy tool employed by the Reserve Bank of India.
• It strives to create a healthy banking channel by requiring banks to keep a specific amount of liquid money on hand to meet client needs.
• It regulates the money supply in a country's economy.
• It's used to keep inflation or deflation in check, depending on which is more prevalent in a country's economy.
• It is used to either inject cash into or drain excess funds from an economy.

 

 

CRR's Impact

 

In this part, we'll look at how CRR affects different market categories.

 

 

Real Estate

 

The market's liquidity would be reduced if the CRR was increased. This indicates that due to the high-interest rates, investors would be hesitant to buy real estate or take out a home loan. Furthermore, the construction industry would see a slowdown since many construction businesses would face a lack of work due to lower demand, and they would be forced to borrow money at higher rates. As a result, construction firms would be hesitant to take on projects that would increase their overhead expenses.

 

Investments

 

Investing is a term that refers to putting money into the economy. When the CRR rises, it's possible that there won't be enough money to invest. This would result in slack and a slowdown in investment. As a result, the economy as a whole is slowing down.

 

Imports and exports 

 

Higher interest rates are frequently associated with an increase in CRR. As a result, industries will limit their product and service production and, as a result, will invest less in production and expansion plans. People would move to foreign goods and services to obtain their desired products, causing imports and exports to rise and fall, respectively. As a result, the GDP of a country is under pressure.

 

Equity and Commodity Market

 

A higher CRR would lead to less investment in the stock market. This would also have an impact on the commodity market. This would be owing to the scarcity of funds available for investment. Furthermore, the primary purpose of the average citizen is to conserve rather than invest.

 

The General Public

 

A rise in the CRR could lead to higher interest rates. As a result, the public's purchasing power would be reduced as spending would be discouraged. When interest rates are high, loans become prohibitively expensive. Existing borrowers, on the other hand, should not be concerned because neither their EMI nor the term of their loan would be altered. With variable interest rates, borrowers can expect their EMI or loan term to increase at any time.

 

The Stock Market

 

The impact of an increase in CRR on the stock market would be negative. Stock prices will fall as a result of this. A slowdown in several industries, such as engineering, manufacturing, banking, and so on, would have a detrimental impact on the stock prices of these companies. As a result, an increase in the CRR would harm the stock market.

 

Conclusion

Cash Reserve Ratio is a mechanism that the central bank uses to control liquidity in the banking sector. The goal is to ensure that banks do not run out of cash to meet their depositors' payment obligations.