What is The Cash Reserve Ratio?

Cash | Reserve Ration | 09th February 2022 | Virtual Wire

 

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All the monetary policies of the country are framed and regulated by The Reserve Bank Of India which is called the regulator of India’s banking sector.

To control the money supply in the economy various steps are taken by the government to regulate the monetary policy in the country. The main purpose to control the money supply is to ensure ample supply of money in the economy, which will help in achieving economic growth, and in controlling inflation. Money supply determines the rates of interest and prices of the different commodities. The tools used by RBI to control the supply of money in the economy are the Cash Reserve Ratio, Repo Rate, Reverse Repo Rate, Bank Rate, and Open Market Operations.


Understanding the CRR

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The Cash Reserve Ratio is used by RBI to control the money supply in the economy. Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the latter as reserves in the form of liquid cash. Commercial banks are required to keep a certain percentage of their total time and demand liabilities with the RBI. types of liabilities:

  • TIME DEPOSIT

  • DEMAND DEPOSIT


TIME DEPOSIT

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Time Deposit is an interest-bearing bank account that has a fixed term or a fixed date to mature. It pays slightly higher interest than the regular savings bank account. It is also called the ‘term Deposit’. Example: Fixed Deposit.


DEMAND DEPOSIT

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A demand deposit is that type of account through which you can withdraw money on your demand. The depositor generally uses this account to pay everyday expenses. Example: Regular checking account, savings account, money account.


WORKING OF CASH RESERVE RATIO

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When RBI decides to increase the CRR, the amount of money with the banks decreases. This way the RBI controls the excess supply of money in the economy. The percentage to be maintained to RBI should not be less than 4% of the total Net Demand and Time Liabilities by the commercial banks. RBI does this on a fortnightly basis in India. The liabilities of a bank consists of all the money market borrowings, certificates of deposits, and investment in deposit in other banks. The higher the Cash Reserve Ratio, the lesser is the amount of Money supply in the economy, and less will be spent and invested by the banks and vice-versa.


HOW DOES CRR AFFECT THE ECONOMY?

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To regulate the money supply, CRR is the main tool used by RBI to keep the inflation levels in check, money supply, and liquidity in the country. The higher the CRR, the lower is the liquidity with the banks and vice-versa. When the pandemic hit the country in 2020 and amidst the lockdowns in the country, RBI reduced the CRR to 3% to increase liquidity in the economy. When inflation hits the economy RBI ensures that excess money supply is not there in the market-leading to which increasing the CRR. It lowers the CRR when the government needs to increase the flow of money in the money market.


ADVANTAGES OF CRR

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  • It helps in building and sustaining the solvency levels of any commercial bank.

  • CRR helps in maintaining the liquidity of commercial banks.

  • CRR helps in maintaining a smooth flow of cash and credit in the economy.

  • CRR is a very efficient tool when reducing or increasing the rates in the market. NO other tool can be as reliable as this.

  • Plays an efficient and positive role in driving the financial environment in the economy.


DISADVANTAGES OF CRR

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  • The biggest con of CRR is Inflation.

  • If commercial banks have large excess reserves then this tool becomes ineffective.

  • Distortion arises due to frequent use.

  • It involves an element of uncertainty.

  • It can cause an extra burden on banks.

Given the importance of the economic recovery and potential employment generation, the RBI may retain the CRR at the current level for some time to come.




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