What does Cash Reserve Ratio (CRR) mean in banking?

Summary: The CRR (Cash Reserve Ratio) often comes up in the RBI monetary policies. It ensures consumers financial security. Know the meaning, objectives & formula.

27 Sep 2022 by Team FinFIRST

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The Cash Reserve Ratio (CRR) often comes up in the Reserve Bank of India’s (RBI) monetary policies. We decode what it means.

Economies are usually volatile. They fluctuate depending on several internal and external factors. Banks and their ability to lend money are especially susceptible to these factors. Proper regulation and financial management can help avoid bumps in banking operations and maintain enough liquidity. The Reserve Bank of India (RBI) uses Cash Reserve Ratio (CRR) to eliminate such risks and regulate the money supply in the market. CRR impacts banks and financial institutions in how they offer loans and other credit products.

What is Cash Reserve Ratio?

The cash reserve is the amount of capital a bank has. The Cash Reserve Ratio (CRR) is the percentage of total deposits a bank must have in cash to operate risk-free. The Reserve Bank of India decides the amount and is kept with them for financial security. The bank cannot use this amount for lending and investment purposes and does not get any interest from the RBI. CRR applies to scheduled commercial banks, while the regional rural banks and NBFCs are excluded.

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Let us use an example to understand CRR further. Assuming the CCR is 6%, a bank must deposit ₹6 for every ₹100 raised in deposits. Technically, the cash reserves for a scheduled commercial bank must not fall below 6% of the total net demand and time liabilities (NDTL) that the bank holds on a fortnight basis. Earlier, CRR ranged from 3% to 20%; however, there is no upper or lower limit now.

Key objectives of the Cash Reserve Ratio

Following are the critical objectives of the Cash Reserve Ratio.

CRR helps control inflation. In a high inflation environment, RBI can increase CRR to prevent banks from lending more.
CRR also ensures banks have a minimum amount of funds readily available to customers even during huge demand.
CRR serves as the reference rate for loans. Also known as the base rate for loans, the banks cannot offer loans below this rate.
Since CRR regulates the money supply, it boosts the economy whenever required by lowering the Cash Reserve Ratio.

While the CRR affects how banks offer loans, you can count on IDFC FIRST Bank to help you whenever you need financial help. The bank provides convenient loans through online and offline channels, offering a hassle-free application process and minimal documentation. You can opt for up to a personal loan of ₹1 crore at competitive interest rates starting at 10.49%.

The Cash Reserve Ratio (CRR) ensures consumers' financial security. It forces banks to maintain adequate liquidity.

How does CRR control inflation?

The Cash Reserve Ratio directly impacts the level of liquidity in the country's economy. You can assume it is a money supply valve RBI holds to control inflation. In case of higher inflation, the RBI can increase the Cash Reserve Ratio requirements to reduce the banks' lending capacity, thereby lowering inflation.

How is CRR calculated?

The Cash Reserve Ratio is calculated based on the bank's net demand and time liabilities (NDTL). Net demand and time liability can be defined as the total deposits of the bank with the public or other banks minus the deposits of other banks. Liabilities such as current deposits, cash certificates, demand drafts, fixed deposits (FDs), gold deposits, dividends etc., constitute NDTL. Here is a simple expression to calculate the cash reserve ratio:

CRR = (Liquid Cash/NDTL) * 100

Why does CRR keep changing?

The RBI keeps changing the cash reserve ratio for consumers' safety and a smooth economy. It ensures that the banks have adequate funds to meet customers' requirements even during high withdrawals. Moreover, RBI can also increase or decrease the CRR to meet its other requirements, such as supplying money to boost the economy.

Knowing how CRR works for banks and financial institutions can help you make informed decisions and choose when to go for a suitable financial product. The Cash Reserve Ratio is a safety net for the customers and is an integral part of RBI's monetary policies.

Disclaimer

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