[ecis2016.org] CRR is one of the most important tools available to the RBI, to monitor liquidity in the banking system
The RBI on May 4, 2022, increased the cash reserve ratio by 50 basis points to 4.5%, a move that is likely to put pressure on interest rates. However, to understand the full repercussion of this move, we must have a clear understanding of what cash reserve ratio or CRR is.
You are reading: What is CRR or cash reserve ratio?
What is CRR?
Banks in India are liable to maintain a certain percentage of their total deposits with the Reserve Bank of India (RBI) in the form of cash. This percentage of their total deposits is known as the cash reserve ratio or the CRR. The money kept as the cash reserve ratio is either sent to the RBI or kept in the bank’s vault.
CRR is a great tool used by the apex bank in India to control the amount of liquidity in the banking system.
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Cash reserve ratio meaning
Simply put, CRR or cash reserve ratio, is a percentage of cash that banks are required to keep in reserves vis-à-vis their total deposits, technically referred to as the Net Demand and Time Liabilities (NDTL).
By making changes in the CRR rate, the apex bank in India is able to keep inflation at its desired level and control and monitor money flow in the banking system.
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Objective of CRR
There are three key objectives of the cash reserve ratio.
To maintain bank liquidity: The RBI, in the capacity of a banking regulator, is responsible for controlling and monitoring liquidity levels. Towards that goal, it infuses or takes liquidity out of a system with the help of the CRR. If the RBI wishes to infuse more liquidity into a system, it lowers the CRR and leaves banks with more liquidity to lend to their customers. On the other hand, if it wants to take out liquidity from the system, it increases the CRR.
To maintain banks’ health: The CRR is an important tool to maintain the fiscal health of banks. Since banks keep the CRR deposited with the banking regulator, they can use this fund when bank customers start to make huge withdrawals. The cash reserve ratio helps banks to safeguard themselves in such situations, as the cash reserve kept with the RBI ensures that banks do not run out of cash to meet the demands of their customers.
To set the repo rate: The RBI is also responsible for periodically setting the repurchase rate or repo rate. This is the minimum rate at which it lends money to commercial banks in India. While setting the repo rate, the RBI also considers the CRR rate. When the Reserve Bank wants banks to infuse more liquidity into the system it lowers the repo rate. Conversely, banks have less money to lend in case the RBI decides to increase the repo rate to tame inflation. To tame inflation, the RBI on May 4, 2022, increased the repo rate to 4.40%. In case inflation starts to go over the comfort limit of the RBI it may, in future, increase the repo rate.
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Cash reserve ratio calculation formula
The rights to set and make changes in the CRR lie with the RBI, as the apex bank in India. If a customer deposits with his bank Rs 1,000 and the cash reserve ratio is 8%, the bank will have to keep Rs 80 as the CRR with the RBI. The bank can keep this amount either in its vault or with the RBI in the form of cash. This also means that the bank can only use Rs 910 of the customer’s deposit for lending purposes.
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If the RBI increases the CRR from, say, 8% to 10% at some point, a bank upon receiving a deposit of Rs 1,000 will have to keep aside Rs 100 as the CRR in its vault or deposit it with the RBI. The CRR cannot be used for lending purposes either by the RBI or by the banks.
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Current CRR rate in India
After the hike on May 4, 2022, the cash reserve rate in India stands at 4.50%. This means, if a bank gets Rs 100 in deposits, it has to keep Rs 4.5 as cash deposits with the RBI. For bank customers, the current CRR rate is an indicator that a certain percentage of their deposits are always safe with the RBI, even if the financial health of their bank becomes weak.
Statutory liquidity ratio (SLR)
Statutory liquidity ratio or SLR is also a reserve requirement that banks are expected to keep aside, before offering loans to customers. SLR is the minimum percentage of deposits that banks have to maintain in the form of cash, gold or other securities.
CRR and SLR : Differences
| CRR | SLR |
| CRR has to be maintained only in cash | SLR can be maintained either in the form of gold or cash |
| CRR is maintained with the RBI | SLR is maintained with the bank |
| Banks do not earn a return on CRR | Banks earn a return on SLR |
While both happen to be tools in the hands of the RBI to contain inflation and monitor the money supply, there are certain differences between the CRR and the SLR.
CRR and inflation
At times when the inflation goes over the level desired by the central bank in India, it typically hikes the CRR rate. However, as it currently walks the tightrope of boosting demand in the aftermath of the two waves of the Novel Coronavirus pandemic, the RBI has maintained the CRR at a low level, to help the economy.
In fact, the consumer price-based inflation (CPI), which is the RBI’s monetary policy anchor, has remained above the upper band of RBI’s comfort zone of 2%-6% for two straight months in May and June 2021. CPI inflation hit a six-month high of 6.30% in May 2021, before marginally easing to 6.26% in June 2021.
Cash reserve ratio FAQs
Who decides the cash reserve ratio or CRR rate in India?
The cash reserve ratio or CRR in India is decided by the RBI’s six-member Monetary Policy Committee during the monetary policy reviews. The cash reserve ratio is among the many tools available to the RBI to manage liquidity and check inflation in the economy.
When does the RBI revise the CRR?
The RBI has the right to make a change in the CRR rate during its policy reviews, which are conducted every six weeks.
How does CRR affect the money supply in the banking system?
The lower the CRR rate, the higher the liquidity with the banks. The higher the CRR, the lower the liquidity with the banks.
How can a high CRR rate impact the economy?
In case of a high CRR rate, the money supply in the system would dry up, negatively affecting investments. Since money would be in short supply, banks would increase the interest rate of loans. This would be detrimental to demand.
How can a low CRR rate impact the economy?
In case of a low CRR rate, banks will have more funds to lend, which would boost demand in the system. They will also lower the cost of borrowing for the customer, encouraging them to invest in assets.
Do banks earn any interest for keeping CRR with the RBI?
Banks do not get any interest on the money that is kept with the RBI under the CRR mandate.
What is NDTL?
NDTL shows the difference between the money a bank has as demand and time liabilities (deposits) and the deposits in the form of assets held by the other bank. Formula to calculate NDTL Bank’s NDTL = Demand and time liabilities (deposits) – deposits with other banks
What is the repo rate?
The repo rate or the repurchase rate is the rate at which the RBI lends money to commercial banks in India. While a low repo rate means banks can get funds from the RBI at a low interest rate, a higher repo rate means the RBI will charge higher interest on loans.
What is the repo rate in India at present?
The repo rate in India at present is 4.4%. This means the RBI charges 4.4% interest on loans. Since the repo rate is currently at a record low, borrowers currently have to pay comparatively lower rates on loans.
What is the reverse repo rate?
The reverse repo rate is the rate at which the RBI borrows money from commercial banks in India. Currently, the reverse repo rate in India is 3.35%.
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