The Cash Reserve Ratio (CRR) mandates commercial banks to maintain a minimum percentage of their total deposits, known as Net Demand and Time Liabilities (NDTL), as cash reserves with the RBI. Essentially, CRR represents the portion of cash deposits held by a bank at the RBI. This regulation is outlined in Section 42 of the Reserve Bank of India Act, 1934.
What is Cash Reserve Ratio?
- The Cash Reserve Ratio (CRR) mandates commercial banks to uphold a minimum percentage of their total deposits, specifically Net Demand and Time Liabilities (NDTL), in the form of cash reserves with the RBI.
- This requirement is applicable to all Scheduled commercial banks.
- For example, if Bank A receives 100 Crores in deposits and the CRR stands at 3%, it must deposit 3 crores in cash with the RBI, leaving 97 crores for its operations.
- When the central bank increases the CRR, the available money for banks diminishes, and conversely when it decreases, the accessible funds rise.
- These cash reserves must be stored either in the bank’s vault or with the RBI.
- Initially governed by Section 42 of the RBI Act 1949, the CRR range was set between 3%-15%, later modified in 2007 to range from 0-15%, eliminating the lower limit.
- As of December 2021, the CRR is held steady at 3%.
Note: Incremental CRR
- This measure is implemented by banks in response to a sudden influx of deposits. Such a scenario could prompt banks to increase lending and inject more money into the economy, potentially fueling inflation.
- Consequently, a distinct Cash Reserve Ratio (CRR) is applied to deposits from a specified date to counteract excessive liquidity.
- This is achieved through the mechanism of Incremental CRR, wherein the RBI absorbs surplus funds.
- Following Demonetisation, the RBI enforced a 100% CRR requirement for deposits made between September 16 and November 11 in Scheduled Commercial Banks.
Objectives of Cash Reserve Ratio
The Cash Reserve Ratio fulfills dual roles:
- It provides a guarantee of safety for the bank’s deposits by holding a portion of them with the Reserve Bank of India, ensuring ease of refund for clients.
- CRR also contributes to inflation control. In times of significant inflation, the RBI increases the CRR, compelling banks to bolster their reserve funds, thus curbing their lending capacity.
Difference between SLR and CRR
| Parameter | Cash Reserve Ratio (CRR) | Statutory Liquidity Ratio (SLR) |
| Meaning | The percentage of deposits (NDTL) that a commercial bank must retain as cash reserves with the RBI. | The minimum percentage of deposits (NDTL) that a commercial bank must keep with itself. |
| Reserves in the form of | Cash only | Liquid cash, gold, or other securities. |
| Maintained with | Reserve Bank of India | Respective Banks |
| Effect | Helps meet short-term liquidity requirements by trading excess securities. | Controls excess money flow in the economy. |
| Interest on Reserve | Banks don’t earn any interest on the CRR deposited with RBI | Banks earn interest based on the portfolio of SLR chosen. |
Conclusion
CRR serves as a short-term liquidity management instrument, in contrast to SLR, which operates as a long-term tool. CRR functions akin to insurance in the event of a bank failure, providing a resource to repay stakeholders. Moreover, it is utilized to inject surplus liquidity into the markets during economic slowdowns.
PYQ for Prelims
Question: When the Reserve Bank of India announces an increase of the Cash Reserve Ratio, what does it mean? (UPSC 2010)
(a) The commercial banks will have less money to lend
(b) The Reserve Bank of India have less money to lend
(c) The Union Government will have less money to lend
(d) The commercial banks will have more money to lend
Answer: (a)
Question: The money multiplier in an economy increases with which one of the following?
(a) Increase in the cash reserve ratio
(b) Increase in the banking habit of the population
(c) Increase in the statutory liquidity ratio
(d) Increase in the population of the country
Answer: (c)
FAQs
Q: What is Cash Reserve Ratio (CRR)?
A: Cash Reserve Ratio (CRR) is the proportion of a bank’s total deposits that it is required to hold in cash reserves with the central bank of a country, such as the Reserve Bank of India (RBI). It is mandated by the central bank to control the liquidity in the economy.
Q: How does CRR affect banks and the economy?
A: CRR affects banks by reducing the amount of funds available for lending and investment purposes since a portion of their deposits is locked up with the central bank. This helps in controlling inflation by reducing the excess liquidity in the economy.
Q: What is the purpose of implementing CRR?
A: The primary purpose of implementing CRR is to ensure financial stability and control the money supply in the economy. By regulating the amount of cash that banks must maintain as reserves, central banks can influence liquidity conditions and thereby manage inflation and economic growth.
Q: How is CRR different from SLR (Statutory Liquidity Ratio)?
A: While CRR mandates banks to keep a certain percentage of their deposits in cash with the central bank, SLR requires banks to maintain a certain percentage of their deposits in liquid assets like government securities, gold, or approved securities. Both CRR and SLR are tools used by central banks to control liquidity, but they serve slightly different purposes.
Q: Can changes in CRR impact interest rates?
A: Yes, changes in CRR can impact interest rates indirectly. When the central bank increases CRR, banks have less money to lend, leading to a decrease in lending activities. To counteract this decrease in lending, banks may raise interest rates to attract deposits. Conversely, a decrease in CRR may lead to lower interest rates as banks have more funds available for lending. Thus, CRR indirectly influences interest rates in the economy.
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