CRR or Cash Reserve Ratio is a tool used by the Reserve Bank of India to keep the Inflation rate under control and also secure public money.
As you know, inflation is the general increase in the price level of goods and services in an economy. In short, it must be kept under control to maximize its benefits. A higher, as well as a lower rate of inflation, can be dangerous to an economy.
CRR (Cash Reserve Ratio)
In simple terms, banks have to keep a certain percentage of money that they receive from their depositors with the Reserve Bank of India. However, banks keep it in the form of cash. That portion of the money is known as ‘CRR.’
But, the banks cannot access that money for their day to day use or credit to the deserved borrowers.
Remember – The CRR ratio is calculated based on NDTL.
You can also check the current CRR here.
An example of CRR
To take an example, if a particular bank receives Rs 100 as deposits at the end of a specific day, then it has to keep Rs 3 for the Reserve Bank of India if CRR is at 3%. In short, the banks have to retain 3% of their deposited money with RBI mandatorily.
Banks may not maintain it daily, but they have to keep 100% CRR on an average basis during the fortnight unless they have to pay the penalty.
Thus, CRR controls the liquidity of money and provides some security to depositors.
Uses of CRR
The Reserve Bank of India monitors inflation, the money supply, and liquidity in an economy.
When the prices of goods and services skyrocket at the time of the high rate of inflation, the Reserve Bank of India increases the CRR ratio.
A higher ratio of CRR means the banks have to maintain a higher amount of their deposits with the central bank. Therefore, it reduces their lending capacity.
Now, they have to increase their interest rate to compensate for their lowered lending capacity. It discourages borrowers from taking loans.
When the total volume and value of loans decrease, the money supply in an economy shrinks, resulting in lesser demand for goods and services. As a result, the growth of the economy is compromised, but inflation is controlled.
To think just the opposite of the above scenario, at the time of deflation or degrowth of an economy, the Reserve Bank of India intervenes and lowers the CRR ratio. As a result, the banks have to maintain a lower amount of their deposits with the central bank, and that results in their higher lending capacity.
Now, they can decrease their interest rate as they have more money to lend, and this step encourages borrowers to take loans.
It implies more money coming into the economy and more demand for goods and services. As a result, the growth of the economy becomes faster, and also the rate of inflation.
Banks make a profit when they lend out money. To make that happen, they may end up exhausting their balance.
We can also see redemption pressure at the same time. Meanwhile, the CRR helps the banks at that time. Consequently, the Reserve Bank of India comes to their rescue and provides enough liquidity for banks’ smooth operation.
When the Reserve Bank of India keeps a certain percentage of deposited money from the banks, it is also a matter of security for the depositors.
|Date||NDTL (In Crores)||CRR Rate||CRR Amount (In Crores)||Remaing Amount in the Bank (In Crores)||Money Supply in the economy|
That is to say; the money supply increases with each CRR rate and vice-versa.
Note: RBI doesn’t give any interest on the money deposited under CRR
In the year 1991, the average Inflation rate had reached 13.88%, and we call it the ‘1991 Indian economic crisis’. Consequently, to control such type of high rate of inflation, the Reserve Bank of India took several steps, including raising the rate of CRR.
The CRR was at 15% at that time. As a result, banks have to keep Rs 15 with the Reserve Bank of India for each deposit of Rs 100.
The CRR was at 15% for more than three years, beginning from July 1989 to Dec 1992. It was the highest rate of CRR, India had ever seen.
CRR plays an essential role in the economy. Therefore, the Reserve Bank of India has to review the economic situation periodically and change the ratio accordingly.
However, it is not the only tool the Reserve Bank of India uses to control inflation and money liquidity. But, there are other tools like SLR, Repo rate, Reverse Repo rate, etc.
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