Cash Reserve Ratio (CRR) - Rate, Meaning, What It Is, Formula, & How to Calculate
Cash Reserve Ratio
The Reserve Bank of India requires banks to keep a portion of their deposits in cash to disperse it to people as needed. The term "Cash Reserve Ratio" refers to the proportion of cash that must be retained in reserves compared to a bank's total deposits. Today, a portion of the bank's deposit is kept secure by the Central Bank because of the cash reserve ratio. Thus it is essential to have a firm knowledge of it. This article discusses everything from what is cash reserve ratio to its significance. Let's take a look at the meaning first.
What Is Cash Reserve Ratio?
A bank's capital is represented by its cash reserve. As mentioned earlier, the percentage of its total deposits a bank must hold in cash to run risk-free is defined as the Cash Reserve Ratio (CRR). The sum is set by the Reserve Bank of India and stored there for financial security. The bank is not permitted to utilize this money for lending or investment purposes, and the RBI does not pay interest. CRR does not cover regional rural banks, NBFCs, and scheduled commercial banks.
Significance Of Cash Reserve Ratio
The cash reserve ratio lays the basis for the banking sector's improved performance. The Cash Reserve Ratio has the following relevance:
- The CRR ratio represents a bank's minimum cash reserves to remain solvent.
- Compared to total bank deposits, it makes up a very modest quantity of liquid cash.
- The rates and the nation's average total amount of liquidity are easier for the reserve bank to manage.
- A bank must reserve this amount of money in the proper proportion. It is chosen and occasionally modified based on the rate of inflation and the amount of cash flowing through the economy.
Economic Impact of Cash Reserve Ratio
The cash reserve ratio in India significantly impacts the economy. The following are the impacts:
The Cash Reserve Ratio is one of the best financial tools used by the RBI to combat inflation, money supply, cash flow, and other factors (CRR). Liquidity amounts decrease and vice versa as CRR levels rise.
When there is inflation, the Reserve Bank raises the CRR level while lowering commercial banks' capacity to borrow money. It thus decreases the amount of money in the economy. Despite having negative consequences on the core economy of the nation, it still manages the weight of inflation.
Similarly, when RBI determines that funds are urgently needed, they lower the CRR threshold, improving credit opportunities for commercial banks. As a result, banks can extend ever more loans to individuals and businesses. As a result, the money supply and economic productivity increase.
Advantages Of CRR
The advantages of the Cash Reserve Ratio are as follows:
- It is a crucial strategy for controlling the amount of money in the economy. A robust credit system will be maintained in place by the economy's robust and dynamic money supply.
- Commercial banks can keep both their own and other banks' liquidity ratio at a high level.
- The CRR system makes it simple to shift funds whenever there is excess in the economy.
Cash Reserve Ratio vs. Statutory Liquidity Ratio
India's monetary policy includes the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). However, there are a few noteworthy distinctions between them. Here are the distinctions:
- The CRR requires every commercial bank to maintain exclusively currency reserves with the RBI. In contrast, the SLR mandates that every private bank maintain reserves in liquid securities. This would apply to both money and gold.
- Banks receive no return on money held in CRR, although they do receive a small return on money held in SLR.
- Under CRR, banks maintain a predetermined cash reserve with the Reserve Bank of India (RBI). However, regarding SLR, it is crucial to protect the liquid instruments that serve as the banks' securities holdings.
- With the aid of CRR, the Central Bank, the RBI, regulates the banking system's liquidity, whereas SLR is a tool for managing a bank's leverage for credit growth.
How is CRR calculated?
The cash reserve ratio is determined based on the firm's total demand and time liabilities (NDTL). The NDTL comprises obligations like current deposits, cash certifications, bank drafts, fixed deposits (FDs), gold deposits, dividends, etc. The sum of the bank's deposits with the public or other institutions, minus the deposit of other banks, is known as net demand and time liability. Here is a straightforward formula to determine the cash reserve ratio:
(Liquid Cash/NDTL) * 100 = CRR
Why does CRR fluctuate so much?
The RBI continuously modifies the cash reserve ratio to ensure the security of customers and a stable economy. It ensures the banks have enough money to cover consumers' needs even during high withdrawal rates. Additionally, the RBI can increase or lower the CRR to satisfy other needs, such as providing funding to boost economic growth.
You can pick when to opt for a good financial product and make informed decisions if you know how CRR operates for banks and other financial institutions. The RBI's monetary policies include the Cash Reserve Ratio, which serves as a safety net for the people.
The number of deposits held as reserves by commercial banks is governed by the CRR, or cash reserve ratio. Central banks employ CRR to regulate a country's lending and interest rates by adjusting money.
As mentioned in this article, the Cash Reserve Ratio is one of the best financial tools used by the RBI to combat inflation, money supply, cash flow, and other factors (CRR). Thus it is crucial to understand cash reserve ration meaning today and how it impacts the economy of a country.