CRR-CASH RESERVE RATIO


The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the Reserve Bank of India (RBI) as a certain percentage of their demand and time liabilities. For example if the CRR is 10% then a bank with net demand and time deposits of Rs 1,00,000 will have to deposit Rs 10,000 with the RBI as liquid cash.
It refers to keeping a portion of net demand and time liabilities (NDTL) of banks with the central banks (In India it’s Reserve Bank of India, RBI). Central bank fixes this percentage of NDTL. Central bank can change this percentage as a monetary measure to control the availability of funds in the economy i.e. to inject liquidity or to suck liquidity. RBI doesn’t pay any interest on such funds held with it. Banks should pay these liabilities on demand which may come at any time.
When a central bank increases CRR, the banks need to reduce the outflow of money by reducing the loans to customers and keep additional amount with the central bank. This usually sucks liquidity in the markets. Let’s examine one by one
Stock Market: Some traders take leveraged positions (usually 4 – 5 times their funds) in stock markets by taking additional funds from their brokers at an interest rate. This interest rate goes up as the funds won’t be available easily. When the interest rate goes up they reduce the amount of leverage or they take the same leverage positions but expect more returns from Stock market which is possible only when the prices go down. So the overall effect is prices will go down.
Bond Market: The banks need to increase interest rates to attract more deposits. The prices of the existing bonds will go down because bonds of same profile will be available with higher interest rates.
Over all Economy: Companies find it difficult to raise funds by issuing debentures/bonds because they need to pay more interest. This may cause them to delay the implementation of their expansion plans and the economy slows down.
Central banks increase CRR only if it feels there is a lot of liquidity in the market and purchasing power of people is more than required (as expected by the central bank) i.e. when the conditions are hyperinflationary.
It reduces the CRR when it feels there is credit crunch in the market and liquidity is very low. The effects will be opposite to the discussed above. This measure is to increase the over all growth rate of the economy. latest rates from the RBI website itself Click Mouse over on reserve ratios (on Right hand side) to see SLR and CRR. http://www.rbi.org.in/home.aspx
How is CRR used as a tool of credit control? CRR was introduced in 1950 primarily as a measure to ensure safety and liquidity of bank deposits, however over the years it has become an important and effective tool for directly regulating the lending capacity of banks and controlling the money supply in the economy. When the RBI feels that the money supply is increasing and causing an upward pressure on inflation, the RBI has the option of increasing the CRR thereby reducing the deposits available with banks to make loans and hence reducing the money supply and inflation.