What is Cash Reserve Ratio (CRR) ?

It is the portion of deposits which the banks in India are supposed to keep in cash. These deposits are held with the Reserve Bank of India (RBI).

Current CRR : 4.75%

Details and facts:

  • It is the portion of net demand and time liabilities (NDTL) of a bank.
  • These are in the form of currency and can also be stored in a bank vault or chest.
  • It is also sometimes referred as the Liquidity ratio, as it is used to control the liquidity in money supply by the RBI.
  • It is a monetary policy tool in the hands of RBI, through which it can control the supply of money in the market, by controlling the capacity of banks to lend or invest.
  • It directly effects the money creation process and reduces the credit expansion.

How is CRR used to control inflation?

Inflation is mainly caused due to increase in purchasing power of the people, which in turn is increased by the supply of loans. So, if the CRR is increased, then the banks’ capacity to lend money to people decreases, eventually decreasing the amount of money offered as loans to the customers. This reduces the purchasing power of the people. But using this,  inflation can be tamed only to certain extent.

Example of CRR:

Suppose that a bank receives a deposit of Rs.1000 and the CRR is 10% at that time, then

The bank will have to keep 10% of its deposits with RBI, which is equal to Rs.100 in this case.

So, the bank is left with only Rs.900, which can be used for investment or lending purposes.

So, if the CRR is increased, the capacity of banks to lend decreases, while if CRR is decreased then banks have more money to lend.

Other important points:

  • Cash Reserve Ratio relates to Scheduled Commercial Banks (excluding Regional Rural Banks).
  • It is used to inject liquidity or suck liquidity from the market.
  • RBI is empowered to increase the rate of CRR to such higher rate not exceeding 20% of the NDTL.
  • Recent RBI amendment act related to this can be read from here.

 

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