Cash Reserve Ratio: Managing the Economy of the Nation

Last Updated at: March 28, 2020
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Latest Update
RBI cuts down the Cash Reserve Ratio (CRR) to 3% to increase liquidity, amid the outbreak of COVID19  
1. RBI provides Rs 3.7 lakh crore liquidity boost to the economy, by cutting down the Cash Reserve Ratio (CRR) to 3%

2. Repo-rate reduced to 4.4%, to encourage further borrowings from the RBI by banks, to ensure more liquidity.

Cash Reserve Ratio in India

Consider a situation where you visit the bank to get a loan funded. But the bank authorities say that they are out of money. Similarly, imagine going to the bank to withdraw your deposited amount, and they refuse for the same. It seems like an impossible situation. Right? This is where the role of the cash reserve ratio comes into play. CRR, abbreviated for Cash Reserve Ratio, is one of the commonly heard words during banking transactions. But what exactly does it mean?

  1. What is the cash reserve ratio?

  2. Importance of maintenance of CRR for banks 

  3. Example to explain what is the cash reserve ratio

  4. Computation of CRR

  5. Impact of CRR on economy and variation of interest rate

  6. Monetary rates

  7. Conclusion

 

What is the cash reserve ratio?

The cash reserve ratio is the minimum amount or percentage of deposits that are maintained compulsorily by every bank. RBI issues the requirements for CRR for all the commercial banks.  Further, being the chief central bank, RBI decides on the CRR percentage according to all the rules and regulations, for commercial banks, which lies in between 3% to 15%. Currently, the CRR in India is 4%.

Example 

An individual X deposits an amount of ₹5,000 in his bank account. Consider the cash reserve ratio to be at 10%. According to the definition of the CRR, the amount that the bank has to maintain mandatorily will be ₹500. Further, the bank can use only ₹4,500 for lending to the customers. The methods through which the banks can lend money include loans for utility purposes.

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Quality of maintenance of CRR for banks

The various banking prospects and monetary tools act as the key factors for the smooth functioning of the economy of the nation. One of these monetary aspects is the cash reserve ratio. The RBI issues a specific set of rules of CRR of banks, which serve the following benefits:

  • Maintenance of liquidity of cash and assets in the market.
  • Having good liquidity is of great benefit for the banks’ operations, helping the banks to maintain a good level of funds.
  • The liquidity is inversely proportional to the cash reserve ratio RBI. So, as the cash reserve ratio increases, the liquidity of the market decreases, and vice versa.
  • Maintaining the cash reserve ratio RBI is of great benefit to the commercial banks. The banks having a good CRR get recognized by the RBI, making it to its good books. This further brings in more customers because of the increased accessibility of funds.
  • The better the cash reserve ratio, the higher are the chances of profits for the banks. Consider this as a cycle, the more the deposit, the more money will be available for lending. The more money lent, the higher will be the profits.
  • The maintenance of CRR is also of benefit to the depositors, as the banks keep some amount of money safe with them.

Computation of CRR

According to the definition of the cash reserve ratio, it is the maintenance of a minimum amount with the banks and several parameters are taken into account by RBI to decide on CRR. To sum up, in one word, the RBI decides the CRR based on NDTL.

NDTL is abbreviated for net demand and time liabilities. Under this, the RBI makes the checking of the account records with the bank, through which it decides the CRR.

Impact of CRR on economy and variation of interest rate

One needs to understand its impact on the economy. The CRR is one of the most important monetary techniques to maintain a stable economic growth of the nation. The various impacts that CRR has on the economy include:

  • Controlling the inflation of the economy. A higher inflation rate can cause a negative impact.
  • Maintaining a stable exchange rate.
  • Administration of money supply, credits, and interest rates.
  • Implementation of the bank rates policy and the credit authorization scheme.

As such, the stability of the CRR leads to a positive impact on the economy of the nation, with each of the above factors playing a significant role.

Monetary rates

Along with the definition of CRR, one must also have a good insight into repo rates and reverse repo rates. These are equally essential, like CRR acting as the financial tools for the economy.

The rates at which the RBI (Reserve Bank of India) lends money to the commercial banks in case of a shortage of funds are called repo rates. Reverse repo rates are just the opposite, i.e., rates at which the commercial banks lend money to the RBI.

Conclusion

After knowing what the cash reserve ratio is that one must be able to calculate how they can manage their finances along with understanding the monetary tools of the government.

 

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Cash Reserve Ratio: Managing the Economy of the Nation

106

Consider a situation where you visit the bank to get a loan funded. But the bank authorities say that they are out of money. Similarly, imagine going to the bank to withdraw your deposited amount, and they refuse for the same. It seems like an impossible situation. Right? This is where the role of the cash reserve ratio comes into play. CRR, abbreviated for Cash Reserve Ratio, is one of the commonly heard words during banking transactions. But what exactly does it mean?

  1. What is the cash reserve ratio?

  2. Importance of maintenance of CRR for banks 

  3. Example to explain what is the cash reserve ratio

  4. Computation of CRR

  5. Impact of CRR on economy and variation of interest rate

  6. Monetary rates

  7. Conclusion

 

What is the cash reserve ratio?

The cash reserve ratio is the minimum amount or percentage of deposits that are maintained compulsorily by every bank. RBI issues the requirements for CRR for all the commercial banks.  Further, being the chief central bank, RBI decides on the CRR percentage according to all the rules and regulations, for commercial banks, which lies in between 3% to 15%. Currently, the CRR in India is 4%.

Example 

An individual X deposits an amount of ₹5,000 in his bank account. Consider the cash reserve ratio to be at 10%. According to the definition of the CRR, the amount that the bank has to maintain mandatorily will be ₹500. Further, the bank can use only ₹4,500 for lending to the customers. The methods through which the banks can lend money include loans for utility purposes.

Get FREE legal advice now

Quality of maintenance of CRR for banks

The various banking prospects and monetary tools act as the key factors for the smooth functioning of the economy of the nation. One of these monetary aspects is the cash reserve ratio. The RBI issues a specific set of rules of CRR of banks, which serve the following benefits:

  • Maintenance of liquidity of cash and assets in the market.
  • Having good liquidity is of great benefit for the banks’ operations, helping the banks to maintain a good level of funds.
  • The liquidity is inversely proportional to the cash reserve ratio RBI. So, as the cash reserve ratio increases, the liquidity of the market decreases, and vice versa.
  • Maintaining the cash reserve ratio RBI is of great benefit to the commercial banks. The banks having a good CRR get recognized by the RBI, making it to its good books. This further brings in more customers because of the increased accessibility of funds.
  • The better the cash reserve ratio, the higher are the chances of profits for the banks. Consider this as a cycle, the more the deposit, the more money will be available for lending. The more money lent, the higher will be the profits.
  • The maintenance of CRR is also of benefit to the depositors, as the banks keep some amount of money safe with them.

Computation of CRR

According to the definition of the cash reserve ratio, it is the maintenance of a minimum amount with the banks and several parameters are taken into account by RBI to decide on CRR. To sum up, in one word, the RBI decides the CRR based on NDTL.

NDTL is abbreviated for net demand and time liabilities. Under this, the RBI makes the checking of the account records with the bank, through which it decides the CRR.

Impact of CRR on economy and variation of interest rate

One needs to understand its impact on the economy. The CRR is one of the most important monetary techniques to maintain a stable economic growth of the nation. The various impacts that CRR has on the economy include:

  • Controlling the inflation of the economy. A higher inflation rate can cause a negative impact.
  • Maintaining a stable exchange rate.
  • Administration of money supply, credits, and interest rates.
  • Implementation of the bank rates policy and the credit authorization scheme.

As such, the stability of the CRR leads to a positive impact on the economy of the nation, with each of the above factors playing a significant role.

Monetary rates

Along with the definition of CRR, one must also have a good insight into repo rates and reverse repo rates. These are equally essential, like CRR acting as the financial tools for the economy.

The rates at which the RBI (Reserve Bank of India) lends money to the commercial banks in case of a shortage of funds are called repo rates. Reverse repo rates are just the opposite, i.e., rates at which the commercial banks lend money to the RBI.

Conclusion

After knowing what the cash reserve ratio is that one must be able to calculate how they can manage their finances along with understanding the monetary tools of the government.

 

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