The Cash Reserve Ratio or CRR is some percentage of its deposits that a bank must keep in liquid cash reserves to pay its customers if and when the need arises. The Reserve Bank of India mandates it. This must be kept either in the bank vault in the form of cash or deposited with the Reserve Bank of India as deposits.
Cash Reserve Ratio Objectives
- The Cash Reserve Ratio calculates the base rate, the minimum lending rate that a bank must charge while lending funds. The Reserve Bank of India fixes this base rate.
- Since a part of the bank's deposit is with the RBI, the Cash Reserve Ratio ensures security.
- The Cash Reserve Ratio helps in controlling inflation in the economy. When inflation is high, the RBI increases the CRR. This leads to lesser money in the hands of the bank and thereby reducing money flow in the economy. This leads to keeping the inflation rate in check.
How is the Cash Reserve Ratio Calculated?
The Cash Reserve Ratio is calculated as a percentage of the Net Demand and Time Liabilities. Suppose we consider that the CRR is 4%. This means that for every Rs 100 deposit, the bank must set aside Rs 4. This rate is fixed fortnightly.
The Net demand and Time Liabilities is calculated using the formula:
(Demand Liabilities +Time Liabilities + Other Demand and Time Liabilities + Liability to Others) – Assets with the Banking System
Difference Between Cash Reserve Ratio and Statutory Liquid Ratio
While CRR needs to be maintained in cash, the Statutory Liquid Ratio can be maintained in liquid assets such as gold, government securities, public sector undertaking bonds, and any other asset specified by the Reserve Bank of India. Also, the SLR funds need not be kept with the Reserve Bank of India. It can be kept with the bank itself.
Why is the Cash Reserve Ratio Not Constant?
Since the motive of the Cash Reserve Ratio is to control the flow of cash in the economy, it is obvious that the Cash Reserve Ratio will fluctuate. To regulate the cash flow in the economy, the Reserve Bank of India sets the Cash Reserve Ratio once a fortnight.
Cash Reserve Ratio Effect on Inflation
The Cash Reserve Ratio has a direct impact on inflation. When inflation is high, the money supply is high. To reduce this, the Reserve Bank of India can increase the Cash Reserve Ratio, thereby decreasing the lending capacities of the banks, which in turn will lead to a reduced supply of money in the economy. The vice-versa is applicable if the Reserve Bank of India wants to introduce a cash influx in the economy.
FAQs on Cash Reserve Ratio
Q.1. Does the bank earn interest on the money set aside as the Cash Reserve Ratio?
No, banks do not earn interest on the money parked as Cash Reserve Ratio.
Q.2. What does a high cash reserve ratio indicate?
A high Cash Reserve Ratio indicates a high inflation rate.
Q.3. Can the Cash Reserve Ratio be kept in the form of gold or government securities?
No, the Cash Reserve Ratio cannot be kept in any form except cash.
Q.4. Who sets the Cash Reserve Ratio?
The Reserve Bank of India is authorized to decide on the Cash Reserve Ratio.