Cash Reserve Ratio (CRR) refers to the minimum amount of funds which the commercial banks are required to maintain as reserves, as required by the Central Bank i.e. RBI . It is an essential monetary policy tool which is used for controlling the supply of money and liquidity in the economy .
The CRR is fixed as per the regulations of RBI . Commercial banks are required to maintain an average cash balance with the RBI, the amount of which shall not be less than 3% of the total of Net Demand and Time Liabilities (NDTL) and go upto 15% of the NDTL. ( NDTL refers to the total of current account, fixed deposit & savings account balances . )
Currently, the CRR of India is 4% which simply means that a bank has to keep 4 rupees with the RBI whenever its deposit increases by 100 rupees.
WHY BANKS HAVE TO MAINTAIN CASH RESERVE RATIO ?
There are 3 primary purposes of cash reserve ratio –
- Since a part of the bank’s deposits is with the Reserve Bank of India, it makes sure that the bank will always have the right amount of cash and not fall short of funds when depositors or customer require funds for their personal needs.
- It helps in controlling the inflation in the economy. At the time of high inflation, RBI increases the CRR rate so that banks need to keep more money in the reserves and have less money to lend .
- Similarly, when there is a need to increase the flow of money in the economy RBI lowers the CRR rate which enables the banks to provide more loans to businesses for investment purposes.
ADVANTAGES OF CASH RESERVE RATIO
- It helps in ensuring the smooth supply of cash as well as credit in the economy.
- It helps in controlling the situation of inflation and deflation by changing the rates of CRR.
- It helps the central bank to administer the rate and the average overall amount of liquidity in the entire country.
- It encourages a bank to be more responsible when lending and dealing with its clients.
EFFECTS OF CASH RESERVE RATIO ON BANKS
Banks prefer CRR when it is low because they have to keep this percentage of funds with the Reserve Bank of India as reserves without earning any interest on these funds. This means this money is kept for free.
High CRR rate means banks will have a lower lending capacity so they will increase the interest rates to discourage people from applying for loans.
Similarly, a low CRR rate means banks will have more money to lend for investment purposes to businesses and industries ,hence the interest rates will be reduced .
Thus, in simple words CRR is an important monetary tool used by RBI to regulate the liquidity position and flow of money in the economy.