RBI increases the cash reserve ratio (CRR) during periods of high inflation to restrict banks' money for loans. It helps remove excess cash from the economy and the credit market.
Banks have recently urged the Reserve Bank of India (RBI) to consider unclaimed deposits or funds in dormant accounts as cash reserve ratio (CRR) to help boost liquidity in the system, media reported on Tuesday, citing people familiar with the matter.
In September last year, RBI Governor Shaktikanta Das favoured drawing on excess CRR to augment liquidity in the banking system. Although surplus liquidity has shrunk noticeably post Covid, the drawdown of banks' excess CRR can enhance liquidity, he told the media.
What Is A Cash Reserve Ratio?
The cash reserve ratio (CRR) is the share of a bank's total deposit in reserve as liquid cash as mandated by RBI. The current cash reserve ratio is 4.5 per cent, updated on May 21, 2022.
CRR is one of the reference rates used for determining the base rate or minimum lending rate below which a bank cannot lend funds. The rate ensures transparency in the credit market and is determined by RBI. It also helps banks to cut their lending cost and provide affordable loans .
CRR ensures a part of the bank's deposit is stored with the central bank for safety and helps keep inflation under control, as the RBI could raise the CRR to curb the money flow in the market. This move usually curtails economic investments as it controls the money flow to curb inflation.
What Are CRR Objectives
RBI increases the cash reserve ratio during periods of high inflation to restrict the banks' money available for loans. It helps remove the excess cash from the economy and credit market.
The banks' cash balance with RBI is determined based on their net demand and time liabilities (NDTL), including public deposits and balances held with other banks.
For example, demand deposits include liabilities, such as current deposits, demand drafts, etc., that banks must pay on demand immediately. On the other hand, time deposits are funds and deposits that must be repaid on maturity, which includes fixed deposits , etc. So, in a nutshell, the higher the CRR, the lower the liquidity available with banks for lending and investing, and vice-versa.
CRR Is A Major RBI Policy
RBI regulates the money flow in the economy with the help of CRR; thus, it is an essential part of its monetary policy. It reduces the flow of money in the economy through CRR during high inflation. Thus the central bank can increase or decrease the CRR depending on the inflation scenario.
When RBI increases the CRR, the banks' available funds for loans to businesses and industries reduce, and when it decreases, they have more funds for loans and investments.
Also, since banks lend out most of the money in their coffers to make higher profits, CRR could come to their aid if they witness an unexpected rush of withdrawals. Any increase or decrease in CRR impacts the economy. CRR helps control volatility by regulating the money flow and accordingly adjusting the interest rates for stability.