Cash Reserve Ratio (CRR)

Cash Reserve Ratio (CRR)

Definition

The Cash Reserve Ratio (CRR) is the percentage of a bank's total deposits that must be held in cash reserves or with the central bank, as prescribed by the regulatory authorities.

Description

As per CRR definition, the key goals of the Cash Reserve Ratio and some of the critical objectives include:

• The CRR serves to manage inflation. In a high-inflation situation, the RBI can raise CRR to deter banks from lending more.
• CRR also assures that banks have minimum funds available to consumers, even during peak demand.
• CRR serves as the loan reference rate. Banks cannot offer loans at a rate lower than this, often known as the base rate.
• Because CRR regulates the money supply, it stimulates the economy when necessary by lowering the Cash Reserve Ratio.

CRR formula:  CRR=TotalDeposits/ RequiredReserves​×100%

Where:

• CRR is the Cash Reserve Ratio,
• Required Reserves is the amount of reserves required to be held by the bank
• Total Deposits are the total amount of deposits held by the bank.

While the CRR influences how banks provide loans, you can rely on IDFC FIRST Bank to assist you whenever you require financial assistance. The bank offers convenient loans through online and physical channels, with a simple application process and minimum documentation. You can get a personal loan of up to ₹1 crore with competitive interest rates starting at 10.49%.

Importance of Cash Reserve Ratio

This is why Cash Reserve Ratio:

Banks must maintain a cash reserve ratio that benefits them and their depositors. 

When banks honestly maintain the statutory CRR rate, depositors do not have to worry about their deposits because some of their money is safe in the form of reserves held with the RBI.

The importance of CRR for banks is as follows:

• Banks allow consumers to open deposits, primarily for lending purposes. Banks prefer to lend the maximum amount of funds to borrowers while keeping very little money for other uses. Banks like low CRR rates. 
• Banks that lend extensively benefit from huge earnings. On the other hand, banks have enough capital to cover a rapid demand for withdrawals when they lend a large amount of their money. 
• This is when CRR enters the picture. The RBI sets the Cash Reserve Ratio rate to avoid scenarios where a bank cannot satisfy repayments due to a lack of money.

How does cash reserve ratio help in times of inflation?

During periods of high inflation, the government must ensure that there is no extra money in the economy.

To that end, the RBI raises the Cash Reserve Ratio, while the quantity of money accessible to banks decreases. This reduces the surplus flow of money in the economy.

• First and foremost, the main objective of CRR is to ensure that a small amount of cash is always accessible to cover deposits. The second is to allow the RBI to control interest rates and overall national liquidity.
• Banks now favour CRR when it is low since they must maintain the specified fund ratio with the RBI while receiving no interest on the reserved fund, implying that the money is held for nothing.
• The rising CRR rate indicates that banks have limited lending ability regarding funds. Consequently, banks would like to open additional deposit accounts. Furthermore, banks will raise interest rates, preventing borrowers from seeking loans because high-interest rates imply higher loan expenses.
• If a depositor has invested in bank equities, an increasing CRR rate means their bank will have smaller margins.
• When the CRR rate is low, banks have more money to invest in other firms, lowering the interest rates on loans.
• A low cash reserve ratio indicates that the banking system's money supply will expand. Increased money supply equals high inflation.

How is CRR calculated?

These are the steps to calculate CRR:

1. Gather the bank details: Calculate the total deposits for the chosen period. This encompasses all sorts of deposits, including demand, time, and savings.
2. Identify cash reserves: Determine the amount of cash reserves that the bank has. Cash reserves comprise actual cash in the bank's vaults and cash deposited with the central bank.
3. Exclude certain assets: Exclude any cash reserves not subject to the reserve requirement. For example, some cash reserves are retained for liquidity purposes but are not required by regulatory authorities to be included in the CRR. In that case, they should be excluded from the computation.
4. Calculate reserves: To calculate required reserves, multiply the total deposits by the regulatory authority's specified CRR percentage. This will provide the reserve amount the bank must keep based on total deposits.
5. Compare Required Reserves to Actual Reserves: Compare the required reserves computed in the previous step to the actual cash reserves held by the bank.
6. Adjust reserves as needed: The bank has surplus reserves to lend or invest if the natural reserves exceed the required reserves. If the actual reserves are smaller than the required reserves, the bank may need to alter its reserve holdings to meet regulatory standards.
7. Report Compliance: Ensure the bank complies with the regulatory requirement by maintaining the required Cash Reserve Ratio. Regularly monitor and report the CRR to the regulatory authority as part of regulatory compliance obligations.
   
    

Trends that can impact CRR
 

Some of the trends that can impact CRR:

1.Monetary Policy Changes: 

Any shifts in the central bank's monetary policy stance directly impact the CRR. For example, imagine the central bank tightens monetary policy to reduce inflation. In that event, it may raise the CRR requirement to lower the money available for lending, thus reducing economic growth. 

Conversely, if the central bank wants to spur economic growth, it may decrease the CRR to encourage banks to lend more, enhancing economic liquidity.

2. Economic Conditions: 

Financial situation fluctuations, such as changes in GDP growth, inflation, or unemployment rates, can all impact the CRR. During periods of economic expansion, banks may receive more deposit inflows, necessitating the retention of additional reserves to fulfil increased credit demand. 

On the other hand, banks may encounter liquidity issues during economic downturns when depositors withdraw funds, leading regulators to change the CRR proportionately to maintain financial stability.

3. Technological Innovations: 

The introduction of new financial technology (FinTech) and digital banking solutions has the potential to impact CRR's efficacy and implementation. 

As digital banking grows more popular, traditional banking models may shift, changing the dynamics of deposit mobilisation and lending practices. Regulators may need to modify CRR rules to account for changes in the banking sector and ensure the efficacy of monetary policy transmission mechanisms in the digital age.

Difference between SLR and CRR

These are the differences between SLR and CRR:
 

Example

Let's say a bank in India has total deposits of ₹500 crore, and the Reserve Bank of India (RBI) has mandated a CRR of 4%.

1. Total Deposits: The bank's total deposits amount to ₹500 crore.
2. CRR Requirement: The RBI has set the CRR requirement at 4%.
3. Calculation: Using the formula for CRR:

Required Reserves=CRR×Total Deposits

Required Reserves=0.04×₹500 crore

RequiredReserves=₹20 crore

Impact: This means the bank must hold ₹20 crore as reserves, either in cash in its vaults or as deposits with the RBI.

In this example, if the bank's actual reserves exceed ₹20 crore, it has excess reserves that it can potentially lend out or invest. However, if the actual reserves fall below ₹20 crore, the bank may need to adjust its reserve holdings to comply with RBI regulations.

FAQ

What is the CRR rate?

The Cash Reserve Ratio (CRR) rate represents the proportion of a bank's total deposits that must be held as reserves with the central bank. Monetary authorities, such as the Reserve Bank of India (RBI) in India and the Federal Reserve in the United States, set it. 

The CRR rate is a mechanism central banks employ to manage liquidity in the banking system and influence the money supply. It is a critical monetary policy tool, influencing lending and economic activity. Banks alter their reserve holdings to meet regulatory obligations based on changes in the CRR rate.

What is the current CRR rate?

The current Cash Reserve Ratio (CRR) rate is the percentage of a bank's total deposits that it is required to hold as reserves with the central bank. Present CRR,  is an important part of the central bank's monetary policy, which regulates liquidity in the banking system and influences economic circumstances.

Difference between SLR and CRR?

SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio) are both tools used by central banks to regulate liquidity in the economy. SLR mandates banks to maintain a certain percentage of their deposits in specified liquid assets, while CRR requires banks to keep a certain percentage of their deposits with the central bank in cash reserves.