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December 29, 2022
By
Reddy Mohith

Cash Reserve Ratio CRR

Getting loans from banks depends on several external and internal factors resulting in the volatility of the finance industry. It is essential to have sound regulation and finance management to avoid disturbances in banking operations and maintain adequate liquidity. To ensure it happens, the Reserve Bank of India (RBI) introduced the Cash Reserve Ratio (CRR) to eliminate the bumps in the finance industry and maintain a steady flow of money in the market. The cash reserve impacts how banks and financial institutions offer loans and other credits. So, this post will help you with all the essential information you need to know about the cash reserve ratio.

What is the cash reserve ratio?

The amount of capital a bank has is the cash reserve ratio, which says the total deposits a bank must have in cash for risk-free operations. The Reserve Bank of India decides the average percentage of CRR, and banks cannot use these funds for lending loans and other investment purposes for which RBI does not provide any interest. The cash reserve ratio applies to scheduled commercial banks while excluding regional rural banks and NBFCs.

Increasing the CRR rates results in lowering the loans issued with high-interest rates. The current CRR rate by which every commercial bank must accept is 4%. The CRR rate is said to increase by 0.5% to 4.5% from 2023.

How do CRR works?

The RBI controls how banks operate within India with the help of CRR. CRR helps in controlling the flow of money. If RBI increases the CRR rate, the cash available with the banks reduces and vice versa, and this is how the RBI controls the excess flow of money in the country or the economy. Every scheduled commercial bank should maintain a CRR of 4% of total Net Demand and Time Liabilities (NDTL) and not below that but can have more than the actual rate.

NDTL tells about the total demand and time liabilities deposits a bank holds, including the balances of a bank with the other banks and the deposits of the general public. The net demand deposits will carry the bank liabilities, such as paying the payments on demand like current deposits, overdue balances, fixed deposits, demand drafts, and savings bank deposits.

On the other hand, time deposits carry deposits that need not be paid immediately, such as fixed deposits. Here, the depositor should wait a certain period to withdraw the money.

Objectives of cash reserve ratio (CRR):

The cash reserve ratio is one of the reference ratios when determining the base rates by the reserve bank of India. The objectives of CRR are:

1. Controls inflation: During high inflation, RBI increases the CRR, which prevents banks from lending more.

2. CRR assures banks to maintain cash readily for customers in demanding times.

3. CRR is the reference rate for loans in commercial banks. It is also known as the base rate that tells the banks that they cannot offer loans below this rate.

4. CRR regulates the flow of cash in the economy. It can increase the economy by lowering the cash reserve ratio rates. And similarly, when there is an excess flow of money, CRR controls it by increasing the cash reserve rates.

CRR effect on the economy:

The cash reserve ratio is one of the essential components of the reserve bank of India's monetary policies. CRR helps to regulate the cash flow and manage inflation and the country's liquidity. The primary effect on the economy due to following the CRR is the controllability of inflation.

Since CRR regulates the flow of money in the nation, RBI uses it to deal with financial circumstances during inflation. The lower the CRR rates, the higher the cash flows. And the higher the CRR rates, the lower the cash flows.

RBI brings financial growth to the nation by controlling the money movements in the economy with the help of a cash reserve ratio. When CRR rates increase, the economy's development gets a negative impact by decreasing the inflation percentage. Similarly, when the CRR rates are lower, the flow of money in the economy increases, resulting in the country's growth.

CRR Calculation:

The CRR calculation depends on net demand and time liabilities (NDTL). Total deposits of the bank with the public or other banks (minus) deposits of other banks give NDTL. The formula to calculate the cash reserve ratio is:

CRR= (liquid cash/NDTL)*100

Reasons for regular changes in CRR rates:

1. For customer safety and a smooth economy, RBI updates the CRR rates regularly.

Banks make profits from lending money to customers in the form of loans. And with that view, the banks may loan out all the cash they have, resulting in left with no liquidity. Doing so will affect the economy and cause disruptions when all customers try to withdraw their money at a time. So, to manage this, RBI changes the CRR rates.

The government also changes the CRR rates for other reasons, such as giving money to boost the economy.

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