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Commercial banks are required to retain a specific minimum amount of deposit as reserves with the central bank under the cash reserve ratio (CRR). Cash Reserve Ratio is the amount of money that must be kept in reserve as a percentage of the bank’s total deposits. The cash reserve is either kept in the bank’s vault or delivered to the Reserve Bank of India. Banks are not permitted to lend CRR funds to corporations or individual borrowers, and they are not permitted to invest CRR funds. And the Banks are not earning any interest on the money.
Need of the Banks to reserve cash
Because a share of the deposits of the Bank is held by the Reserve Bank of India, the currency is safe in the event of an emergency. When clients want their deposits returned, cash is easily available. The minute there is excessive inflation, the government must ensure that at hand there is no extra money in the economy. Furthermore, the CRR helps in the regulation of inflation. As soon as the economy is threatened by rising inflation, the Reserve Bank of India raises CRR, compelling banks to preserve more money in the reserves, essentially lowering the amount of money accessible to them. This reduces the extent of money flowing into the economy.
Significance of the CRR
The CRR controls the country’s inflation rate and the supply of money.
CRR protects the security of the reserved amount because the Reserve Bank of India stores the particular amount of the bank’s deposit, which is easily available as needed by clients.
The CRR aids in the control of inflation. When the country’s inflation is strong, the Reserve Bank of India advances the CRR rate to restrict the quantity of money accessible in banks. This reduces the economy’s excess money supply.
The lower the CRR, the greater the bank’s liquidity, which is then used for investment and lending, and vice versa. Higher CRR can have a negative influence on the economy since it reduces the availability of loanable money, which slows investment.
With the help of CRR in Times of High Inflation
When there is excessive inflation, the government must ensure that there is no extra money in the economy. As a result, the Reserve Bank of India advances the CRR, reducing the sum of money that is available to banks. This reduces the amount of money flowing into the economy. When the government has to inject cash into the system, the Cash Reserve Ratio rate is lowered, allowing banks to lend to a larger number of enterprises and industries for investment purposes. Lowering the CRR also enhances the economy’s growth rate. When the RBI has to infuse funds into the market, it reduces the CRR rate, allowing banks to lend to a larger number of enterprises and industries for investment purposes. Lowering the CRR also enhances the economy’s growth rate.
Effects of the CRR
The basic goal of the CRR is to ensure that a slight sum of currency is constantly accessible against deposits, and RBI will be able to control the overall liquidity and the interest rates in the state. When Cash Reserve Ratio is low, then the banks favour it as they need to meet the RBI’s stipulated fund ratio without receiving an interest held in reserve funds, which means the amount is tied up for nothing. The rising CRR rate suggests that banks’ ability to lend money is constrained. As a consequence, banks are looking to open more deposit accounts. Banks will also hike rates of interest, discouraging the borrowers from obtaining loans as the high rates of interest indicate higher loan expenses.
When a depositor has invested in a bank’s stock, a high CRR rate means that banks will have lower margins. When the cash reserve ratio rate is less, the bank has more funds to finance n some other business, which results in lowering the interest rates of loans. A less CRR also signals that the money supply of the banking system will expand. Increased supply of money aggravates inflationary pressures.
Advantages of the CRR
CRR helps to control total liquidity by allowing money to circulate freely throughout the economy. The quantity of money accessible in the financial market determines the CRR rate. When the money supply expands, the RBI boosts the CRR to clear the excess funds. In the case of a liquidity crisis or a decrease in the country’s economic monetary supply, then the RBI can cut the CRR rate to let more money into the market. Subsequently, some other benefits of the CRR are as followed-
CRR helps commercial banks strengthen and preserve their solvency, and it ensures that all commercial banks’ liquidity systems are consistent and adequate.
Commercial banks can give extra advances to the borrowers when the Cash Reserve Ratio rate is reduced by the RBI, enabling a seamless supply of cash and credit in the economy.
When the market interest rate drops sharply, CRR absorbs liquidity and helps to improve the rate.
Using the CRR instead of other monetary instruments like Market Stabilization Scheme bonds is more effective.
CRR plays a positive impact in improving the financial climate when the currency is overvalued.
Conclusion
CRR is a tool for managing short-term liquidity. It’s similar to insurance that can be used to compensate the investors if the bank fails. During market slowdowns, it is utilized to push extra liquidity into the market.
