Cash Reserve Ratio: Meaning and Calculation

The Reserve Bank of India (RBI) monitors the credit flow and money supply in the Indian economy. It is tasked to keep inflation in check while providing enough liquidity to propel economic growth. The RBI regulates the country’s banking sector and controls liquidity in the financial system for which it uses certain quantitative as well as qualitative measures. One such measure is the Cash Reserve Ratio (CRR), through which the central bank regulates the credit flow of banks and other financial institutions.

Let us explore the cash reserve ratio meaning and how is CRR calculated.

What is Cash Reserve Ratio?

Cash Reserve Ratio is the percentage of total deposits that commercial banks are required to keep with the Reserve Bank of India in the form of cash reserves. It is the share of a bank’s total deposit that is to be mandatorily kept with the RBI in the form of liquid cash for financial security.

Commercial banks cannot use this amount for lending and investment purposes. They even do not get any interest from the central bank on these deposits.

The RBI uses CRR to ensure that banks have sufficient cash reserves to meet their depositors’ demands for cash withdrawals. Thus, it is also used to increase or decrease the amount of money available in the economy. It helps in maintaining the stability of the financial system and control inflation. At present, the CRR is 4.50%.

Objectives of Cash Reserve Ratio

The primary objective of the CRR is to ensure that the banks have sufficient cash reserves to meet the withdrawal demands and maintain stability in the financial system. There are many more key objectives of CRR which are as follows:

CRR is used by the RBI to control inflation in the economy. The central bank regulates the money supply in the economy by increasing or decreasing the CRR. The CRR is increased to reduce the amount of money available for lending. This reduces the money supply and controls inflation.

CRR also helps to ensure that commercial banks have a certain minimum amount of funds readily available to customers during huge demand.

The central banks can reduce CRR and increase the money supply in the economy to pump prime growth whenever required.

Impact of CRR on the Economy

The Cash Reserve Ratio has a significant impact on the economy. Any change in CRR affects the liquidity and money available for lending.

When the economy suffers from higher inflation, the RBI can hike the CRR requirements which will lead to a reduction in the commercial banks’ lending capacity. This will reduce the supply of money in the economy and slow down investment and ultimately lower inflation in the economy. Thus, by raising CRR, the central bank can reduce inflationary pressures and control inflation.

On the contrary, RBI can reduce CRR when there is a need to boost economic growth. By reducing CRR, the money available for lending will increase, which can be used to propel economic activities. Thus, CRR can have a tremendous impact on the economy.

How is CRR Calculated?

The CRR is calculated as a percentage of a bank’s Net Demand and Time Liabilities (NDTL). Banks are required to maintain a certain percentage of their NDTL total deposits with the central bank in the form of cash reserves. NDTL is the aggregate savings account, current account and fixed deposit balances held by a bank.  

Difference between CRR and SLR

Cash Reserve Ratio and Statutory Liquidity Ratio (SLR) are both monetary policy tools used by the RBI to regulate the money supply in an economy. However, there are certain key differences between CRR and SLR.

The CRR is the percentage of total deposits that commercial banks must keep as cash reserves with the RBI. On the other hand, SLR is the percentage of total deposits that banks have to maintain in the form of liquid assets such as cash, government securities or gold.

The CRR is a more direct tool for controlling the money supply, while the SLR is more focused on ensuring that banks have sufficient liquidity.

Banks earn interest on SLR deposits, while they do not earn any returns on CRR deposits.

In the case of CRR, the RBI holds the cash reserve of the banks. Whereas, in SLR, the commercial banks themselves hold the securities and preserve them in the form of liquid assets.

Cash Reserve Ratio FAQs:

Q. What happens if a bank fails to maintain the required CRR?

A. The banks will be penalized by the RBI if they fail to maintain the required CRR. The penalty can be in the form of a fine or a reduction in the bank’s lending capacity.

Q. Can the CRR be negative?

A. No, the CRR cannot be negative. It is always a positive percentage of a bank’s total deposits.

Q. Can the CRR be changed frequently?

A. Yes, the central bank adjusts the CRR periodically for specific policy objectives.

Q. What is the current CRR and SLR?

A. The current CRR is 4.5%, while SLR is 18%.

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