The cash reserve ratio or CRR is one of the financial tools available to the RBI for regulating the money supply in the market. In this post, we will learn what the cash reserve ratio is all about.
The cash reserve ratio is a specific proportion of currency that all institutions must deposit with the RBI. The RBI determines this percentage and is periodically adjusted. The bank is not permitted to use this fund for lending or investment. Also, the bank receives no interest from the RBI. CRR applies to scheduled commercial banks but not to regional rural banks and NBFCs.
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The CRR is currently 4.50%. Hence, this implies that, with each Rs 100 in deposits, the bank must maintain Rs 4.5 as a reserve with the RBI.
The objective of the cash reserve ratio is:
As the most prominent banking institution in the nation, the RBI is responsible for upholding the liquidity levels in the banking sector. If the RBI determines to bring more liquidity into the financial sector, it will decrease the CRR ratio. Also, if it determines that it needs to withdraw liquidity from the banking system, it will boost the CRR ratio.
Since all banks throughout the nation must maintain a certain amount of their funds in the form of currency holdings with the RBI, they have access to these funds when consumers make large withdrawals. The primary objective of the cash reserve ratio is to safeguard banks so that they don't run out of their cash reserves to meet customers' demands.
The RBI, as the apex financial institution, is also responsible for determining the repurchase rate, also known as the repo rate. It represents the rate at which the Reserve Bank of India lends to commercial institutions in the nation.
When the central bank boosts market liquidity, it reduces the repo rate and vice versa. To combat inflation, the RBI frequently raises the repo rate.
Now that we know what the cash reserve ratio is all about, let's look at the formula to calculate the CRR. For illustration, if the cash reserve ratio is 6%, then for each Rs. 1000 deposited with an institution, the bank will put Rs. 60 with the RBI as cash reserves. Therefore, this provides the institution only Rs. 940 of the entire deposit for other borrowing needs.
The amount maintained as the CRR is not available for use by the RBI or any other bank in the country for lending purposes.
So the formula is: CRR = (Liquid Cash/Net Demand and Time Liabilities) X 100
NDTL or Net Demand and Time Liabilities refers to the sum of the bank's deposits with the public or other financial organizations minus the bank's deposits in other financial institutions. Liabilities like current deposits, demand drafts, cash certificates, fixed deposits (FDs), bullion deposits, dividends, etc., constitute NDTL.
The cash reserve ratio helps to control inflation and oversee market liquidity. When the CRR increases, banks in the nation have less available liquidity.
When the inflation rate rises, the Reserve Bank of India (RBI) raises the CRR. So this reduces the funds that banks can lend to consumers. This hinders economic growth by decreasing the money supply and lowering inflation rates.
When the RBI lowers the CRR, the money supply increases in the economy. Hence, this allows banks to grant more loans to consumers. Thus, this contributes to the expansion and development of the economy.
To protect customers and the economy, the RBI adjusts the cash reserve ratio. It guarantees banks have adequate money to meet customers' demands amid high withdrawal rates.