What is Cash Reserve Ratio (CRR)?
The commercial banks keep hold of a specific least amount of the deposits as a reserve with the central bank. The percentage of the cash that is kept in reserves against the bank’s total deposit amount is called Cash Reserve Ratio (CRR). The cash reserve ratio is kept in the bank or is transferred to the RBI. Banks do not use that money for investment purposes or earn any interest on that money.
Purposes Of Cash Reserve Ratio (CRR)
In determining the base rate, The Cash Reserve Ratio plays its role as a reference rate. RBI decides the base rate. It is a fixed rate and makes sure transparency in the credit market. The Base Rate also helps the banks to reduce their cost of lending in order to enhance affordable loans.
Except this, there are two main purposes of The Cash Reserve Ratio:
1. CRR ensures security.
2. CRR controls inflation because when inflation is at its peak in the economy, RBI increases the CRR to decrease the bank loanable funds.
The Working Of The Cash Reserve Ratio
The RBI decision to enlarge the Cash Reserve Ratio reduces the amount of money that is available with the banks. This is the way RBI controls the excess flow of money in the economy. The cash balance that is to be kept by schemed banks with the RBI should not be less than 4% of the total NDTL, Net Demand, and Time Liabilities.
NDTL includes deposits of common people and the balances held by the bank with other banks. Demands deposits include all those liabilities of a bank that can be paid on demand like current deposits and cash certificates.
Time deposits include the deposits that need to be paid back on maturity and where the person who has deposited cannot withdraw money at once. Instead of it, he has to wait for some time in order to get the funds in his hands. The liabilities of a bank include call money market borrowing, certificate of deposits, and investment in deposits in other banks.
The CRR Influence On The Economy
CRR is helpful to regulate the supply of money, level of inflation, and liquidity in the country. When inflation increases, steps are taken in order to bring down the flow of money in the economy.
To do this, RBI lowers the available funds in the bank that can be lent and increases the CRR. This is how it slows down investments and stops the supply of money in the economy. As a result, the growth of the economy is badly affected negatively and helps to bring down inflation.
On the other side, when the RBI needs to increase funds into the system, it lowers CRR, which raises the funds that can be lent to the banks. Thus. the banks make a large number of loans available to businesses and industries for different investment purposes. It also grows the overall supply of money and boosts the growth rate of the economy.