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MONETARY POLICY Cash Reserve Ratio PART 5 BY AYUSSH SANGHI
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Cash Reserve Ration (CRR) Cash Reserve Ratio (CRR) is the amount of funds that the banks are bound to keep with Reserve bank of India as a percentage (proportion) of their Net Demand and Time Liabilities (NDTL) k The objective of CRR is to ensure the liquidity and solvency of the Banks. The CRR is maintained fortnightly average basis
Objective Main objective of CRR is to: ak n the financial system and enough solvency for the Banks.
How does CRR work? * CRR is altered by RBI Reduction of CRR In case of reduction of CRR, excess funds are available with banks for deploying in other businesses because they are required to keep lesser amounts with RBI. This means that the banks would have more money to lend and this leads to reduction of interest rates on Loans provided by the Banks
How CRR Works? Impact on Inflation Reduction in CRR leaves more money in the hands of commercial banks and this leads to increase in the money supply in system. When money supply rises, too much money chases too few goods and this leads to rise in inflation.
How CRR Works? Increase in CRR When RBI increases the CRR, less funds are available with banks as they have to keep larger portions of their cash in hand with RBI. * This infers that banks will now have less money to lend. Reserve Bank also does not pay any interest on the CRR balances Since commercial banks don't earn any interest, the banks are left with no option but to increase the interest rates.
How CRR Works? Increase in CRR If RBI hikes this rate substantially, banks will have to increase the loan interest rates. Example: Home Loans, Car Loans increase. k Thus hike in CRR leads to increase of interest rates on Loans provided by the Banks. Reduction in CRR sucks money out of the system causing decrease in money supply. When money supply decreases, the inflation automatically comes down.
How is the rate of CRR fixed? There is a ceiling on CRR. RBI, earlier, was empowered to fix the rate between 3-20%. But from 2006 the upper and lower limits on CRR were removed. Now RBI is empowered to fix the CRR on its discretion without any ceiling.