All About Cash Reserve Ratio - Meaning, Advan and Example

When computing the Base Rate, one of the reference rates is the Cash Reserve Ratio or CRR. The minimum lending rate set and regulated by the Reserve Bank of India is known as the “Base Rate” (RBI). It should be emphasised that no bank can lend money at a lower rate than this benchmark. The Base Rate has been fixed at a predetermined number to ensure the transparency of borrowing and lending in the credit market. 

Additionally, it is essential for lowering the cost of bank loans. As a result, banks offer more affordable loans.

Therefore, the objectives of the CRR are mainly as follows.

• The CRR ensures that the Central Bank has a part of the bank’s deposit. Therefore, part of the deposit is safe.
• CRR also maintains inflation and keeps it under control. The RBI increases the CRR to lower the bank’s loanable funds during high inflation in the economy.

How Does Cash Reserve Ratio Work? 

The amount of money available at the banks decreases when the RBI raises the Cash Reserve Ratio. This is how the RBI manages the excessive money flow in the economy. The total NDTL, or Net Demand and Time Liabilities, shouldn’t be less than 4% of the cash balance scheduled banks must maintain with the RBI. This is completed every two weeks.

The time liabilities (deposits) and total demand held by the banks are called NDTL. Both public deposits and the bank’s accounts with other banks are included. Demand liabilities, such as current deposits, remaining amounts, demand draughts in past-due fixed deposits, and the liabilities of savings deposits, are all included in demand deposits that must be paid immediately.

Time deposits are sums of money that must be repaid at maturity and from which the depositor cannot instantly withdraw funds. Instead, they must wait until a specific amount of time has passed before they can get the money. This covers fixed deposits, the percentage of savings bank deposits devoted to time liabilities, and employee security deposits.

Call money market borrowings, investments, and certificates of deposit in other banks are all included in a bank’s liabilities. In other words, the quantity of money available to banks for investment decreases as the Cash Reserve Ratio rises.

Time liabilities and demand (deposits) with public sector banks and other banks are referred to as NDTL (Non-Deposit Time Liabilities).

How Does CRR Affect the Economy? 

One of the key elements of the RBI’s monetary policy, utilised to control the nation’s money supply, liquidity, and level of inflation, is the cash reserve ratio (CRR). The liquidity with the banks is lower and vice versa when the CRR increases. It is attempted to stop the flow of money into the economy when inflation is high.

To compensate, RBI raises the CRR, which reduces the banks’ available loanable funds. In turn, this slows down investment and lowers the amount of money available to spend in the economy. The result is a detrimental effect on the economy’s growth. However, this also helps in bringing down inflation.

However, when the RBI injects cash into the system, it lowers the CRR, raising the banks’ loanable funds. In turn, the banks grant a sizable number of loans to industries and businesses for various investment goals. Additionally, it expands the economy’s overall money supply. This ultimately accelerates the economy’s growth rate.

Difference Between CRR & SLR

Both the Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR) are elements of India’s monetary policy. But there are a few significant differences between them. The differences are illustrated in the following table.

Cash Reserve Ratio (CRR)	Statutory Liquidity Ratio (SLR)
The CRR requires every commercial bank to keep only cash reserves with the RBI.	Every commercial bank is required to have SLR reserves in the form of liquid assets. Both money and gold would fall under this.
On money set aside as CRR, banks receive no return.	On the money set aside as SLR.
Banks keep a specific cash reserve with the Reserve Bank of India under CRR (RBI).	In the case of SLR, it is necessary to keep the securities held by the banks in liquid assets forms.
With the aid of CRR, the central bank, the RBI, manages the banking system’s liquidity.	SLR is a tool for managing a bank’s leverage when expanding credit.

Why is Cash Reserve Ratio Changed Regularly?

According to RBI regulations, each bank must hold a percentage of its total deposits, which may also be maintained in currency chests. This is regarded as the same as the RBI retains a copy. This ratio may occasionally fluctuate at predetermined intervals, according to the RBI. The economy is affected when this ratio changes.

Profits are generated for banks through lending. Banks may lend the most significant amount to achieve this objective, increase earnings, and maintain a shallow cash position. Banks will only be able to cover some of the repayment demands if customers suddenly rush to withdraw the deposits.

Therefore, CRR is essential to ensure that a specific percentage of all warranties in each bank is constantly maintained securely with them. While the CRR’s primary duty is to ensure liquidity against deposits, it also significantly regulates the economy’s interest rates.

By adjusting the amount of available liquidity in the system, the RBI manages the short-term volatility in interest rates. The RBI raises interest rates to reduce inflation when cash is abundant in the economy. In contrast, when there is a cash shortage, the RBI lowers interest rates to promote economic growth.

As a result, it is wise for you to be aware of the CRR that is currently in effect. It guarantees that a portion of your money is safe with the RBI regardless of the bank’s performance.

Current Repo Rate and Its Impact

The RBI uses many metrics in addition to CRR to control the amount of money in the economy. In response to the shifting macroeconomic conditions, RBI adjusts both the reverse repo rate and the repo rate. Each time the RBI changes the rates, the effects on the various economic sectors differ.

Changes in repo rates may directly impact large-ticket loans like mortgages. Financial institutions and banks may adjust their MCLR proportionately in response to changes in repo rates. The internal reference rate banks use to determine the interest rates they can charge on loans is called the MCLR (Marginal Cost of Funds Based Lending Rate).

Banks may lower their lending rates due to a fall in the repo rate. The debtors of retail loans may benefit from this. The lender must, however, lower its base lending rate to reduce the loan EMIs. According to RBI guidelines, banks and financial institutions must quickly pass on the benefits of interest rate reductions to consumers.

Need For Banks To Maintain CRR

The Reserve Bank of India continuously monitors the cash flow throughout the Indian economy. It contains various financial tools and mechanisms to regulate and manage the economy in many elements. The cash reserve ratio is one of these crucial monetary tools. Every bank in India is expected to follow the CRR guidelines given to them by the RBI.

Every bank can effectively administer and manage the overall liquidity when they each maintain the required CRR. Each bank will gain from this, in turn. When depositors or customers need money for personal needs, a bank will always have the appropriate amount of cash on hand and won’t run out of money. The operations of any bank would greatly benefit from this.

One should be aware that the economic system will have low liquidity when the CRR maintained with the RBI is high. The opposite is also true: the higher the overall liquidity of the financial system, the lower the CRR maintained with the RBI.

Advantages Of CRR

Following are the advantages of CRR:

• The cash reserve ratio helps any scheduled commercial bank develop and maintain its solvency position.
• It ensures that scheduled commercial banks’ liquidity systems are constantly maintained to a high standard.
• It aims to ensure that the country’s economy has an uninterrupted flow of credit and cash.
• The Reserve Bank of India can manage and coordinate commercial bank loans by implementing a cash reserve ratio.
• A scheduled commercial bank will be able to provide additional loans, such as personal loans, vehicle loans, home loans, and other forms of credit, to borrowers across the country when the Reserve Bank of India lowers the cash reserve ratio. This will increase the amount of money flowing to the general populace.
• The cash reserve ratio is an excellent tool for absorbing liquidity when market interest rates sharply decline. The instrument’s operation will aid in improving the falling rates.
• When compared to relying on other financial instruments like Market Stabilization Scheme (MSS) bonds, implementing the cash reserve ratio is more effective. Typically, MSS bonds take a long time to control the nation’s liquidity system.
• Every time there is a rupee surplus situation, the cash reserve ratio helps to moderate the economic environment.

Importance Of Cash Reserve Ratio

You should be aware that banks permit their clients to open deposits primarily for lending to create a “spread.” Banks typically prefer to lend borrowers the highest amount possible while keeping the least amount possible in the bank for other uses.

Increased lending will aid banks in making large profits. However, suppose a bank uses a significant portion of its assets for lending, and there is an unexpectedly high demand for withdrawals. In that case, the bank won’t have enough money to make comfortable repayments. The cash reserve ratio enters the picture at this point. The RBI sets the CRR for banks to prevent situations where the bank lacks the resources to make repayments due to excessive lending.

Ensuring that there are always modest amounts of liquid funds available against deposits is the CRR’s primary objective. The CRR’s ability to help the RBI manage rates and the overall liquidity of the country is its second primary objective.

Effects Of CRR

The increase and decrease in the CRR rate affects a lot of things, some of which are enlisted below: 

Effects of Decrease in CRR

• Interest Rates

Banks will have more money to invest in other industries when the RBI lowers the cash reserve ratio since there will be less money needed to be held on hand at the RBI. This indicates that banks will have an excess of cash, which will decrease the interest rates levied on loans.

• Inflation Effects

Commercial banks will have more money when the cash reserve ratio is kept as low as possible, increasing the amount in the banking system. A rise in the money supply will cause high inflation because money will be abundant.

When the CRR is minimised, money is excessively taken out of the economy, which has a negative impact on the money supply and creates a funding shortage. In this situation, the money supply has shrunk, lowering inflation.

Effects of Increase in CRR

Banks will have relatively little money when the cash reserve ratio is increased because they are required to keep enormous quantities of cash on hand with the Reserve Bank of India. Banks won’t have any money left over to use for other things. Additionally, keep in mind that the RBI does not pay interest on CRR holdings.

Banks now opt to hike interest rates since they cannot receive any interest. The interest rates on their loan products, such as personal loans, car, home, and two-wheeler loans, will have to be raised. Even the borrowers’ equated monthly instalments (EMIs) will rise as interest rates increase, and this will, in turn, lead to a hike in loan costs quite dramatically.