Cash reserve ratio (CRR): Full Form, Meaning, Calculation, Differences, Objective in Banking

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Navigating the financial landscape can feel like an uphill journey. One term that frequently appears in the banking world yet often leaves many perplexed, is the Cash Reserve Ratio or CRR.

In this blog, we unpack the full form, meaning, and objectives of the CRR rate and delve into the significant difference between CRR and SLR. We also cover what is CRR in banking, specifically in the Indian context, and look at the current cash reserve ratio. So sit back, and let's embark on this monetary expedition together.

What is CRR?

As an essential tool in the central bank's armory, the cash reserve ratio is important for maintaining the stability and health of the banking system. The reserves under the CRR system must be held in cash. Banks cannot use these reserves to invest or lend to customers, marking it as an essential safeguard within India's financial infrastructure.

Regulatory Mechanism: The RBI routinely regulates the CRR rate in response to the broader economic scenario. This regulatory power helps in controlling the supply of money within the economy.

Role in Economic Stability: CRR plays a crucial role in maintaining economic stability as a tool to combat inflation and deflation, maintaining a balanced growth trajectory.

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Key Objectives of the Cash Reserve Ratio

At its core, the cash reserve ratio represents a part of a bank's total deposits held back in reserve. The main objectives of maintaining the cash reserve ratio in India include:

Ensuring Liquidity: With a portion of deposits held in cash, banks are well-equipped to meet withdrawal demands by customers. A high CRR rate allows banks to navigate periods of unexpected cash demand smoothly.

Maintaining Bank's Health: By setting aside a part of deposits, banks create a buffer against potential financial distress or even bankruptcy. In other words, the cash reserve ratio is a form of financial self-insurance.

Setting of the Repo Rate: The CRR indirectly influences the repo rate (the rate at which the RBI lends to commercial banks) and the reverse repo rate (the rate at which the RBI borrows from commercial banks). A higher CRR typically corresponds to a higher repo and reverse repo rate.

How is CRR Calculated and How It Works?

The Cash Reserve Ratio plays a crucial role in shaping monetary policy and maintaining stability in the financial system. The calculation of CRR and its workings are outlined in the following points:

CRR Calculation: The CRR is a specific percentage of a commercial bank's total deposits, as decided by the central bank. For instance, if the CRR rate is 4% and a bank has a total deposit of INR 1,00,000, it will have to set aside INR 4,000 (4% of INR 1,00,000) as reserves.

Purpose of CRR: As per the cash reserve ratio definition, the primary objective of CRR is to ensure that banks have enough liquidity to meet customer withdrawals.

Usage of Deposits: The balance deposit after setting aside the reserve is available to the bank for lending or investment purposes. Using the previous example, out of the total INR 1,00,000 deposit, the bank can use the remaining INR 96,000 for giving loans or making investments.

Regulatory Role: By increasing the CRR rate, RBI can reduce the funds available for loans, thereby contracting the supply of money. Conversely, by reducing the CRR, it can increase the supply of money.

How Does The Cash Reserve Ratio CRR Affect Interest Rates For Borrowers And Depositors?

The CRR rate holds considerable sway over the interest rates for both borrowers and depositors. Here's how:

Borrowing Costs: A high cash reserve ratio may lead to higher interest rates on loans. With less money available to lend, banks may charge more to borrowers to compensate for the reduced loanable funds.

Deposit Rates: The interest earned by depositors can also be affected by the cash reserve ratio rate. If the CRR is high, banks have less money to lend, which may result in a lowest housing loan interest rate being offered on deposits.

Supply-Demand Dynamics: A higher CRR often reduces the supply of money in the market. In this scenario, demand for loans can surpass the supply, leading banks to charge a higher interest rate. Conversely, a lower CRR boosts the supply of money, potentially reducing borrowing costs.

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Difference Between CRR & SLR

The Cash Reserve Ratio and the Statutory Liquidity Ratio (SLR) are both fundamental instruments used by India’s highest regulatory bank to ensure financial stability in India. However, they serve different purposes and are calculated differently. Here's a look at their key distinctions:

Parameters	CRR	SLR
Definition	It refers to the percentage of the total deposits in a bank that must be held in cash.	A ratio of a bank's total deposits in cash, gold, or approved securities.
Purpose	Primarily controls the supply of money and maintains liquidity in the banking system.	Ensures the bank's solvency and controls credit growth.
Composition	Only cash reserves are considered.	Comprises cash, gold, and approved securities.
Rate	Generally lower than the SLR.	Typically set higher than the CRR.

Conclusion:

Navigating the financial landscape is not so difficult. A closer look at the cash reserve ratio, its calculation, effects, and the difference between CRR and SLR can offer valuable insights.

Whether you're contemplating a house loan or simply wish to understand the workings of the Indian banking system, knowing what lies beneath these banking terms is beneficial.

Current Repo Rate FAQs

What does CRR stand for?

CRR stands for Cash Reserve Ratio, a regulatory measure requiring banks to hold a certain percentage of their deposits as cash.

Why is CRR important?

The CRR rate helps ensure liquidity in the banking system, stabilize interest rates, and safeguard against financial distress.

How does CRR impact interest rates?

By controlling the amount of money available for banks to lend, the cash reserve ratio influences both lending and deposit interest rates.

What are the benefits of maintaining CRR in home loans?

The CRR provides stability in the house loan market by ensuring that banks have adequate reserves, helping prevent a potential credit crunch.

Can CRR can be used as a means for financial inclusion?

Indeed, properly implementing CRR can support broader economic stability and financial inclusion.

How is the Cash Reserve Ratio, CRR determined, and who sets it?

The RBI determines the CRR rate based on economic conditions and monetary policy objectives.

How does the Cash Reserve Ratio, CRR impact a bank's lending capacity?

By setting a limit on the funds available for lending, the cash reserve ratio directly impacts a bank's lending capacity.

How does the Cash Reserve Ratio, CRR affect interest rates for borrowers and depositors?

CRR changes influence loanable funds in banks. A higher CRR might increase borrowing costs and decrease deposit interest rates.

What is CRR? Know Its Full Form, Definition, Objective & Differences with SLR