This direct control enables a more precise and immediate impact on liquidity conditions in the banking system. It ensures that the funds are available in case of a surge in demand. Other liabilities could take the form of call money market borrowings, certificates of deposit, interest deposits in other banks, dividends, etc. Banks have been mandated by the Reserve Bank of India (RBI) to maintain a fixed amount of cash as a part of the cash reserve ratio (CRR). Now, banks prefer CRR when it is low because they need to maintain the specified ratio of funds with RBI without earning any interest on the reserved fund that means the money is kept for free.

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You can assume it is a money supply valve RBI holds to control inflation. In case of higher inflation, the RBI can increase the Cash Reserve Ratio requirements to reduce the banks’ lending capacity, thereby lowering inflation. They fluctuate depending on several internal and external factors. Banks and their ability to lend money are especially susceptible to these factors.

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CRR is a percentage of the total deposits that banks are required to keep with the RBI. The higher the percentage, the less money banks are able to make loans, which leads to a slowdown in economic growth. The cash reserve ratio is the portion of the cash that the central banks ask respective commercial banking institutions to keep aside and not use for lending or investment purposes. The minimum portion of the money to be held on to is known as the reserve requirement. The commercial banking institutions might reserve the cash in their vaults or deposit it with the central banks.

The central bank is the institution that determines the required amount of reserve ratio. A bank’s reserve usually consists of money it has and is held in its vault. Its implementation and adjustments are key elements in shaping the overall monetary framework of an economy. 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.

What is CRR (Cash Reserve Ratio)- Meaning & Formula

• The CRR also provides a transparent and targeted approach to address liquidity concerns and mitigate risks in specific banks or sectors.
• Conversely, a lower CRR may result in higher overall liquidity in the economy.
• The demand liabilities of the bank are all liabilities that the banks must pay when demanded.
• 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 calculation ensures that the bank adheres to the required liquidity norms set by the RBI. Banks are required to maintain the prescribed reserve percentage, ensuring a continuous effect on the money supply and liquidity conditions in the banking system. There are other tools like statutory liquidity ratio (SLR), repo rate, reverse repo rate, open market operations and a few others. A liquidity crunch could happen due to many reasons, which could be domestic or global.

Difference Between CRR and SLR

The cash reserve ratio defines how banks can help stabilize prices by limiting the amount of money they can lend, thereby reducing excess liquidity and general demand. CRR plays a central role in the RBI’s monetary policy, controlling the country’s money supply, inflation, and liquidity. The reserve requirement acts as a buffer against unexpected shocks and ensures that banks have adequate liquidity to meet their obligations. The CRR serves as a tool for managing liquidity in the banking system. By adjusting the CRR, the central bank can either inject or withdraw liquidity from the market. Increasing the CRR reduces the amount of funds available for lending, while decreasing the CRR increases liquidity and encourages lending.

What is the Current CRR & its Impact?

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Registration granted by SEBI, membership of BASL (in case definition of cash reserve ratio of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. The examples and/or scurities quoted (if any) are for illustration only and are not recommendatory. Repo (Repurchase Agreement) is a short-term borrowing mechanism where banks borrow funds from the RBI by selling securities. Reverse repo is the opposite, where banks lend funds to the RBI in exchange for securities. An increase or decrease in the cash reserve ratio affects the economy. In this blog, we will discuss the cash reserve ratio meaning, the CRR formula, how to calculate CRR , and why it is important for the economy, and the stock market.

• The Reserve Bank of India (RBI) has decided to gradually restore the cash reserve ratio (CRR) in two phases in a non-disruptive manner.
• The Cash Reserve Ratio also provides a means through which risks can be minimized by banks.
• The Cash Reserve Ratio directly impacts the level of liquidity in the country’s economy.
• Cash Reserve Ratio (CRR) is always a common topic of discussion in the Reserve Bank of India’s (RBI) monetary policy.
• This reserve requirement ensures that banks have enough funds to meet customer withdrawals and other obligations.

The Hargreaves Lansdown provides access to a range of investment products and services for UK investors. Banks earn interest on SLR deposits, while they do not earn any returns on CRR deposits. Whether you’re an aspiring entrepreneur, trader, or just someone keen on financial growth, our comprehensive insights on personal development, finance, and leadership are tailored for you. The rate of CRR depends on the Net demand and Time Liabilities(NDTL). These products are governed by our Terms and Conditions, Privacy Policy, and any other product and partner specific terms and conditions as communicated to you. The features, benefits and offers mentioned in the article are applicable as on the day of publication of this blog and is subject to change without notice.

By adjusting the CRR, the central bank can influence the lending capacity of banks. Increasing the CRR reduces the number of funds available for lending, which helps in controlling excessive credit growth and preventing asset bubbles. Requiring banks to maintain a certain level of reserves helps ensure the stability of the banking system. The CRR acts as a buffer against unexpected shocks, providing a safety net for banks and protecting depositors’ interests. It ensures that banks have sufficient reserves to meet their obligations and can withstand financial disruptions. The process ensures transparency and aligns with the RBI’s mandate to maintain price stability and promote the stability in economy.

The CRR is usually different from nation to nation and sometimes varies with economic conditions. For example, if there is high inflation, then the central bank shall increase the CRR to decrease the cash available for lending, resulting in a reduction in inflation. Increasing the percentage of deposits that banks must keep in the form of vault cash causes a decrease in the amount of lending that they are able to do. While the effectiveness of reserve requirements as a policy tool is highly debatable, there’s little doubt that it influences the money market.

By increasing the CRR, the central bank reduces the amount of funds available for lending by commercial banks. This helps in curbing excess liquidity in the economy, reducing the money supply, and thereby controlling inflationary pressures. This acts as a monetary policy tool used by central banks to regulate the money supply in the economy. By adjusting the CRR percentage, central banks can influence the liquidity available to commercial banks.