Cash Reserve Ratio

In today’s world , banks have become one of the most important elements in everybody’s life. All of us make transactions, withdraw money, or deposit money with the help of a bank. Bank helps us in saving money, borrowing money through loans, and earning money through interest. Banks are also responsible for the circulation of money. Usually, when an individual deposits money, the bank does not keep the money with themselves. They give the money as loans to someone else and grow the money. It is a continuous process. However, it also creates inflation. Therefore, when the government notices that inflation in the country is going out of control, the government increases the cash reserve ratio to control the amount of money being circulated in the economy. 

What is the Cash Reserve Ratio?

When the government bank notices that the inflation rate in the country is increasing extensively, it exercises its powers on commercial banks and increases the cash reserve ratio. The cash reserve ratio is the ratio of money that determines the percentage of any given deposit of money that is to be kept by the bank instead of sanctioning it as loans to some other account holder. The amount of money that is to be kept by the bank must be in liquid form. Which means the amount of money should be kept in cash. 

What is the Importance of the Cash Reserve Ratio ?

• Cash Reserve Ratio makes sure that the bank has enough liquid money so that all the customers can have some amount of funds even though there is an increased level of demand.
• Cash Reserve Ratio is another way of telling, that some amount of deposit money is in the control of the government bank. This helps in securing some amount of money with the bank.
• When the country experiences extensive inflation, the government bank can manipulate the CRR easily. This will help the government banks to keep a check on the money supply in the market. This further leads to a decrease in inflation. Similarly, to promote healthy inflation the government can also decrease the ratio to increase inflation.
•  Cash Reserve Ratio Rate also manipulates the supply of money in the market, when cash reserve ratio decreases it helps in increasing the supply of money, likewise if the cash reserve ratio is increased it helps in decreasing the level of money supply in the economy. 
• CRR also controls the base rate at which loans can be sanctioned. That means loans of a given amount of money that is lower than the base rate cannot be sanctioned by a commercial bank. The base rate helps in making lending of money transparent and the cash reserve ratio helps in giving a base rate to lend a sum of money to the account holders.

Conclusion

CRR is an important tool for the government to gain control over commercial banks. If the rate of CRR is increased then the amount of money left of the bank is very limited as they have to keep a big sum of money as cash in hand with the government bank. Therefore, it leaves very little money for the commercial bank to spend on some other purpose. Moreover, the government bank does not pay any amount of money as interest on the cash reserve ratio. When commercial banks do not get any amount of money as interest on cash reserve ratio, they tend to increase the rate of interest.  Therefore, commercial banks increase their rate of interest on loans. They increase the rate of interest on personal loans, home loans, car loans, etc. When the interest rate goes higher, the EMIs of the borrowers of the money increase as well. Therefore, the cost of loans increases a lot. Hence, the CRR is beneficial to both the government and the commercial banks when it is used with proper planning and understanding. This cash reserve ratio plays an important part in the economics of a country.