What is CRR and How Does It Impact the Economy?

Economies are generally volatile, with several factors -internal or external- determining how much they fluctuate. The ability of a bank to lend money is directly impacted by these factors. Therefore, it is essential to maintain proper regulation to avoid any obstacles in banking operations while maintaining sufficient liquidity. This is where the concept of Cash Reserve Ratio (CRR) plays a role.One of the most important monetary policy tools used by the Reserve Bank of India (RBI), CRR helps reduce any risks and regulates the supply of cash in the economy. Let us understand the concept’s meaning, its objectives, and how it can impact the economy.

The amount of capital a bank possesses is known as its cash reserve. The Cash Reserve Ratio (CRR) is the percentage of total deposits a bank must possess in liquid cash to operate risk-free. The cash reserve is determined and kept with the RBI itself. The bank cannot use this amount for investment or lending, nor does it earn any interest from the RBI for it.The Cash Reserve Ratio is applicable to all scheduled commercial banks. When the RBI increases the CRR, banks are required to hold a larger proportion of deposits in reserve. This decreases the amount of money available for lending, consequently slowing economic growth. Also read: Decoding Banking: How Banks Generate Revenue

To understand how CRR works, consider the CRR is 4.5%. This indicates banks must reserve ₹4.5 every time there is an increase in deposits by ₹100. Therefore, the cash reserve held by the RBI must not go below 4.5% of their total Net Demand and Time Liabilities (NDTL.) The timeline for this concept is considered on a bi-weekly basis. Therefore, when RBI increases the CRR, it is a way for the institution to control the excess flow of money in the market.NDTL is defined as the total deposits, or demand and time liabilities held by banks. NDTL includes balances held with other banks, deposits made by citizens, etc. Demand deposits are the liabilities the bank must pay on demand. Time deposits are amounts that need to be paid on maturity. They also include deposits wherein the depositor needs to wait to gain access to funds.Cash Reserve Ratio can be calculated as (Liquid Cash/NDTL) * 100

Given below are a few essential objectives of the Cash Reserve Ratio:• CRR ensures banks have a threshold amount of cash readily available in case of higher demand.• CRR is a great tool that helps to control inflation. If the inflation is high, RBI has the option to increase the CRR, which prevents banks from lending to a significant extent.• CRR regulates the money supply, thereby boosting the economy.• CRR works as a reference rate or base rate for loans. Therefore, banks cannot offer a loan at a rate lower than the CRR. Also read: Everything about the Base Rate in a Home Loan

One of the most important parts of RBI’s monetary policy, CRR, is an effective tool to regulate money supply, liquidity, and inflation in the country. Therefore, higher CRR equals lower liquidity for banks. The RBI increases CRR to combat inflation and reduce liquid cash available with the banks. And though this can impact the economy, it can also bring down inflation. On the other hand, the RBI lowers the CRR to increase liquid funds with banks. This increases the money supply in the market and boosts the economy.Let us try to understand the impact CRR can have on the economy.
• A change in CRR can affect the money supply in the market. A higher CRR decreases the liquid funds available to banks and, consequently, a reduced capacity for lending. Alternatively, a lower CRR equals higher lendable resources, and increasing money supply.• During a spell of high inflation, RBI might increase the CRR, reduce liquidity, and control excessive lending. Therefore, a higher CRR helps to control inflation by limiting the amount of cash available in the market.• An increase in CRR equals lesser resources for banks, which may lead to a scarcity of funds. This can lead to a hike in interest rates as banks might need to work around lesser liquidity. A lower CRR can lead to lessening interest rates due to a higher availability of funds.• A higher CRR might decrease the bank’s profitability as banks do not earn interest on cash reserves kept with the RBI. Therefore, a higher cash reserve equals lesser availability of cash for lending and lesser potential earnings for the bank.• A higher CRR equals lesser funds available to banks for lending. This can lead to more stringent lending standards and lesser credit availability. On the other hand, a lower CRR can improve credit availability as banks will have more resources to lend.

Statutory Liquidity Ratio and Cash Reserve Ratio are two critical components of RBI’s monetary policy; however, the two concepts have a few important differences. Let us try to understand how the two policies differ.

The RBI regularly changes the Cash Reserve Ratio for a seamless economy and consumer safety. Establishing the correct CRR means that banks can have sufficient funds to meet customer needs despite heavy withdrawals. The RBI also changes CRR to meet requirements such as boosting the economy.

The current Cash Reserve Ratio, or CRR, is 4.5%. Effective since May 21, 2022, the CRR is a critical aspect of the RBI’s monetary policy. Also read: How Banks Calculate Interest on Savings Accounts and Fixed Deposit

Cash Reserve Ratio is an integral part of RBI’s monetary policies. Not only does the concept help boost the economy, but it also ensures banks have enough liquidity to meet customer needs even under high-withdrawal scenarios. This concept is used by the RBI to control inflation and adjust the money supply in the market. Knowledge of the concept of CRR also helps you to make informed decisions regarding the right financial product. Therefore, not only is CRR an important part of monetary policies, it is also a safety net for customers. Also read: What are The RBI Guidelines for Home Loan?