Updated on June 13, 2022, 5:12 a.m.

The banking segment is the major component of our economic growth and it is the major pillar of the financial segment, playing a major role in the working of our economy.

The growth of our nation is linked with the development of banking and a sound banking system will play a major role in mobilising the savings in various segments. The banks in India have gone through a wonderful phase through the rapid changes brought about by the reforms in the financial segments.

What is Cash Reserve Ratio (CRR)?

Let’s us understand the concepts regarding the Cash Reserve Ratio, it is a specified minimum amount from the total deposited amount taken from the customers, where in the commercial banks in India need to display as reserves in cash or the deposits with the apex banking establishment known as the Reserve Bank of India (RBI). It is the cash reserve that is maintained and the upkeep of certain amount is done to make sure that banks do not run out of any money during sudden withdrawals by customers on a large scale due to market fluctuations and other reasons.

The Cash Reserve Ratio rates are decided by the apex body known as the RBI and the conditions are reviewed quarterly.

Let’s us consider an example, if the SBI gets the deposit of INR 100 Crores and the current CRR ratio is 4%, then SBI will need to maintain the 4% of INR 100 Crores, that is INR 4 Crores as cash and use the remaining capital as INR 96 Crores of the cash for investment or lending for various purposes. The lower the CRR rates the commercial banks will be happy as they can park some amount with the RBI without receiving interest on the amount.

As per the current guidelines by the Reserve Bank of India on May 21, 2022 under the leadership of Governor Mr. Shakthikantha Das, all the banks in India must maintain the Cash Reserve Ratio of 4.5%. RBI keeps changing CRR periodically in accordance with inflation and liquidation.

How is the CRR Calculated?

If you look from the technical angle, the CRR is calculated as the percentage of the Net Demand and the Time Liabilities and refers to the Aggregate Account, Current account and the Fixed Deposits Balances that is held by the bank. The formula for calculating the CRR will be

CRR = Liquid Cash/NDTL * 100

Demand Liabilities Deals with

  • Mail Transfers
  • Demand Drafts
  • Current Deposits
  • Outstanding Telegraph Transfers
  • Margin against the Letter of Credits
  • Balances in Overdue Fixed Deposits
  • Credit Balances in the Cash Credit Accounts
  • Deposits held as the securities for Advances
  • Cash Certificates and Cumulative and Recurring Deposits

Time Liabilities Deals with

  • Fixed Deposits
  • Gold Deposits
  • Cash Certificates
  • Staff Security Deposits
  • Recurring and Cumulative Deposits
  • Margins held against the Letter of Credits
  • Deposit held as Securities for Advances not payable on Demand.

How CRR Interest Rates and Inflation are Related?

The Cash Reserve Ratio (CRR) Interest Rates and Inflation are connected with each other in a simple manner.

  • The RBI will increase the Cash Reserve Ratio.
  • Banks will have less money for lending purposes.
  • Banks will need to increase the lending rates to maintain profits.
  • Interest rates will increase.
  • Customer will borrow less money due to increased interest rates.
  • In the market the interest rates will rise.
  • Supply of the money will get reduced tremendously.
  • Demand of the products will come down drastically.
  • The inflation will get controlled and regulated to greater extent.

Importance of the Cash Reserve Ratio

The importance of the Cash Reserve Ratio is given below as follows:

  • The CRR ensures that some share of the bank’s deposits is with the RBI and is very secured.
  • This is the faster means compared to other monetary instruments in smooth supply of cash and credit in the economy.
  • This is brought to bring the inflation under the control by asking banks to stop lending the amount.
  • This helps in controlling the supply of the money in the economy and has a stronger positive effect.
  • Increased CRR indicates banks will have a reduced lending capacity.
  • Lower CRR will make banks happy as they can get huge profit margins and have enhanced business.
  • This helps in enhancing the declining rate by taking in the burden
  • at a time when the market rates go down.

How Does the Cash Reserve Ratio Function?

When the Reserve Bank of India enhances the CRR, the money available with the bank gets reduced and banks will not lend the money to the customers in spite of having good payment history. This is the best way introduced by the Reserve Bank of India in reducing the excess flow of the currency in the economy.

The cash balance that must be maintained by the banks in India under the umbrella of the Reserve Bank of India must not be lesser than the 4 % of the overhaul Net Demand and Time Liabilities (NDTL) on a fortnightly basis. This will be completely influenced by the deposits given by the general public and the balance that is maintained by various banks in India.

If you want to know the formula behind the Net Demand and Time Liabilities is Demand and Time Liabilities --- Deposits with other Banks.

Advantages of the Cash Reserve Ratio

There are various advantages of the Cash Reserve Ratio given below as follows:

  • It plays a major role in controlling and mitigating the risks.
  • The interest rate accrued on the loans will be the lowest.
  • This helps the banks in India to create and hold on to the comfort position.
  • Reducing the Cash Reserve Ratio will play a major role in increased cash flow in the economy in the form of grants and loans.
  • This is a superior and faster means to regulate the economic growth compared to other monetary instruments like bonds and stabilisation schemes.
  • CRR play a vital role in absorbing the liquidity situations when the market rates go down immensely.
  • Maximum lending activities by banks helps in good returns and will be able to handle huge withdrawals by customers in India.

Hence, it is vital to know how the CRR will play a pivotal role in the nation building and mismanaged can lead to increased inflation.

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