CRR Full Form

What is the full form of CRR?

CRR stands for Cash Reserve Ratio. It is the minimum amount set by the central bank to be maintained by commercial banks from public deposits with the central bank, or in other words, it is a proportion of the total cash held by the bank. It is the share of the total deposit of commercial banks that they have to keep with the central bank in the form of liquid cash and acts as a tool that the central bank uses to control liquidity in the banking system.

This Story also Contains

1. What is the full form of CRR?
2. Cash Reserve Ratio Objectives
3. CRR Formula
4. Advantages of CRR
5. Difference Between CRR and SLR
6. Conclusion

It is a certain percentage of the total cash held by the bank. CRR changes from time to time. RBI decides on CRR and hence banks have to keep a certain percentage of their deposits with RBI.

Commercial banks are required to maintain an average cash balance with the RBI. This balance should not be less than 3% of Net Demand and Time Liabilities (NDTL) on a fortnightly basis. RBI is empowered to increase CRR up to 20% of NDTL.

The cash reserve ratio is calculated as a percentage of each bank's net demand and time liabilities. Net demand and time liability are arrived at by the sum of savings account, current account, and fixed deposit balances.

Cash Reserve Ratio Objectives

The cash reserve ratio serves two main purposes:

• The Reserve Bank of India, which holds a portion of bank deposits, ensures that the money is safe. This makes it easier for clients to return deposits.
• In addition, CRR helps in controlling inflation. When the economy is experiencing significant inflation, the RBI will increase the CRR, forcing banks to hold more money in reserves, and reducing their ability to lend.

CRR Formula

Below is the formula for calculating the cash reserve ratio:

Cash Reserve Ratio = (Minimum Reserve Requirement/Bank Deposits) * 100% Minimum Reserves = Cash Reserve Ratio * Bank Deposits Where Reserve requirement refers to the cash reserve that a bank must maintain with the central bank. Bank deposits represent the bank's total deposits.

Let’s take an example to understand better

Assume that the Federal Reserve sets the CRR as 9%. In such a scenario, a banking institution with a deposit of $100 million can easily calculate the required minimum reserves that it must deposit in its vault or deposit in the Reserve.

Solution:

Based on the above formula, the bank derives the equation for determining the required minimum reserves when deposits and indicators are already provided:

Reserve Requirement = CRR * Deposits

= 9/100*100 million

= 9 million

Banks would therefore be required to hold $9 million, which would no longer be available for lending and investment purposes.

Advantages of CRR

CRR helps in expanding money circulation in the economy to manage overall liquidity. The CRR rate is fixed according to the money supply in the financial market. When there is an increase in the money supply, the RBI immediately increases the CRR to remove the excess funds. Similarly, in case of a lack of liquidity or a decline in the money supply in the economy, RBI will reduce the CRR rate to release more money into the market. Let's look at the other benefits of the cash reserve ratio.

• CRR helps commercial banks build and maintain solvency.
• Ensures a consistent and well-maintained liquidity system in all commercial banks.
• RBI gains control and coordination of credit maintained by banks through the CRR rate, which helps ensure the smooth flow of cash and credit in the economy.
• When the CRR rate is reduced by the RBI, commercial banks can offer more advances to borrowers, which in turn increases the flow of cash to the public.
• CRR helps improve the falling rate by absorbing liquidity when market interest rates fall sharply.
• The implementation of the cash reserve ratio is more effective than other monetary instruments such as bonds under the market stabilization scheme. Mainly because MSS bonds will take a lot of time to manage the country's liquidity system.

• During the rupee surplus situation, CRR plays a constructive role in easing the financial environment.

Difference Between CRR and SLR

• Cash reserve ratio and Statutory Liquidity Ratio(SLR) are two different central bank policies. However, both are mandatory requirements of every bank.
• CRR is a certain percentage of the total bank deposits required in the current account of the central bank. Banks do not have access to this amount for any economic or business activity and the bank cannot lend this money to any lenders; nor can they use it for investment purposes.
• On the other hand, SLR is money invested in various specified central government securities. It is a certain percentage of the total bank deposit. Banks can earn interest against CRR on investment in SLR.

Conclusion

CRR is a short-term liquidity management tool, unlike SLR which is a long-term tool. CRR is like insurance against bank failure that can be used to pay out stakeholders. It is used to push excess liquidity into the markets during a slowdown.