Cash reserve ratio financial definition of cash reserve ratio

Similarly, when the CRR rate is low, banks have more money to invest in other businesses this reduces the interest rates charged on loans. Cash Reserve Ratio maintained by banks holds importance for both Banks as well as the depositors. However, when the CRR rate for the amount maintained with RBI is high, the liquidity in the economy will be low. The Cash Reserve ratio works vice versa, the lower the CRR reserved with the RBI, the higher will be the economy’s overall liquidity. Cash Reserve Ratio or CRR is the minimum amount as specified by the Central Bank, to be maintained by the Commercial banks of the public deposits with the Central Bank.

• They can lend more to businesses allowing for higher liquidity circulating in the economy to boost economic activity and growth.
• When there is an increase in monetary supply, the RBI instantly increases the CRR to remove the excess funds.
• The penalty can be in the form of a fine or a reduction in the bank’s lending capacity.
• The central bank is the institution that determines the required amount of reserve ratio.
• Do remember that CRR is just one of the tools and cannot  be responsible for controlling the liquidity situation alone.

Whereas, in SLR, the commercial banks themselves hold the securities and preserve them in the form of liquid assets. These articles have been prepared by 5paisa and is not for any type of circulation. Any reproduction, review, retransmission, or any other use is prohibited. 5paisa shall not be responsible for any unauthorized circulation, reproduction or distribution of this material or contents thereof to any unintended recipient. Kindly note that this page of blog/articles does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction.

How Do You Calculate a Reserve Requirement?

Thus, RBI can even increase the cash reserve ratio during periods of inflation to limit the issuance of loans. The CRR is calculated as a percentage of a bank’s Net Demand and Time Liabilities (NDTL). Banks are required to maintain a certain percentage of their NDTL total deposits with the central bank in the form of cash reserves. NDTL is the aggregate savings account, current account and fixed deposit balances held by a bank. When the economy suffers from higher inflation, the RBI can hike the CRR requirements which will lead to a reduction in the commercial banks’ lending capacity. This will reduce the supply of money in the economy and slow down investment and ultimately lower inflation in the economy.

• ICICIdirect.com is a part of ICICI Securities and offers retail trading and investment services.
• The Reserve Bank of India (RBI) has decided to gradually restore the cash reserve ratio (CRR) in two phases in a non-disruptive manner.
• The cash reserve ratio is a legal requirement and therefore it is also called as a Statutory Reserve Ratio (SRR).
• Conversely, when the CRR means is low, banks may have more funds at their disposal for lending, which can stimulate economic activity by making loans more accessible and affordable.
• A. Yes, the central bank adjusts the CRR periodically for specific policy objectives.

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The Board of Governors cut the reserve requirement ratios to zero percent on March 26, 2020. “This action eliminated reserve requirements for all depository institutions,” the Board states on its website (as of October 2023). In the US, time deposit and savings accounts are not subject to reserve requirements, but checking accounts are. The reserve ratio is sometimes called the bank reserve ratio, the cash reserve ratio (CRR), or the bank reserve requirement. The Cash Reserve Ratio (CRR) influences the amount of funds that banks can lend to consumers and businesses.

The cash reserve ratio is an essential tool in the hands of central banks to manage the money supply in the economy, control inflation, and ensure financial stability. Its importance can be seen from the fact that it is used by most central banks around the world. However, it is important to strike a balance between the need to control inflation and the need to ensure adequate credit availability to promote economic growth. Cash Reserve Ratio (CRR) is always a common topic of discussion in the Reserve Bank of India’s (RBI) monetary policy. The capital a bank possesses is represented by its cash reserve.

Definition of CRR

The banking institutions, therefore, are not allowed to finance any borrower below that base rate. As the rate fixed by the central banks is the same for all lenders, the national credit market becomes more trusted and transparent. A central bank increases this portion of cash reserves when it aspires to limit the use of funds to be lent out or invested. On the other hand, it lowers the cash reserve ratio if it desires to encourage lending and investment in the market. Cash Reserve Ratio (CRR) is the amount of cash banks need to hold on to without being allowed to invest or lend it for interest. Also known as the reserve ratio, this percentage lets the commercial banks find out the portion of monetary reserves they need to keep with their respective central banks.

Banks with net transaction accounts of up to $16.3 million or less were not required to have a reserve requirement. The majority of banks in the United States fell into the first category. The Fed set a 0% requirement for nonpersonal time deposits and Eurocurrency liabilities.

Cash Reserve Ratio (CRR): A Key Banking Tool

In many cases, stockholders are able to tell when variations in reserve ratios will take place by scrutinizing macroeconomic patterns. The CRR is often used as a monetary policy tool by the central bank to influence the country’s interest and borrowing rates by altering the funds available for banks to make loans with. The CRR is a powerful tool used by the RBI to regulate the liquidity in the banking system. When the CRR is high, banks are required to hold a more substantial portion of their deposits with the RBI. This, in turn, reduces the funds definition of cash reserve ratio available for lending to customers, which can lead to higher interest rates for borrowers and a decrease in overall liquidity in the economy. The reserve ratio helps banks and lenders obtain base rates at which they would lend money to loan seekers.

In the West, central banks seldom change the CRR since it would cause instant liquidity problems for banks having low excess reserves. There, they normally prefer using open market operations like selling and buying government bonds to control the monetary policy. In China, the central bank (The People’s Bank of China) utilizes the CRR as a tool to fight inflation. It had increased the reserve requirement 10 times in 2007 and 11 times since 2010 beginning. The purpose of the CRR ratio is to ensure the stability of the banking system and control inflation. By mandating banks to keep a certain percentage of their deposits with the central bank, it can control the amount of money that is available for lending in the economy.

In China, the People’s Bank of China uses a reserve requirement ratio to manage the money supply. To calculate the reserve requirement, take the reserve ratio percentage and convert it to a decimal. For example, if the reserve ratio was 11%, and a bank had a deposit of $1 billion, you would multiply 0.11 x $1 billion to get a reserve requirement of $110 million. When banks source deposits from the public, the key goal of the bank is to lend and, in turn, to earn a spread.

The CRR is the percentage of total deposits that commercial banks must keep as cash reserves with the RBI. On the other hand, SLR is the percentage of total deposits that banks have to maintain in the form of liquid assets such as cash, government securities or gold. The Cash Reserve Ratio (CRR) is the percentage of total deposits a bank must have in cash to operate risk-free. The Reserve Bank of India decides the amount and is kept with them for financial security. The bank cannot use this amount for lending and investment purposes and does not get any interest from the RBI. CRR applies to scheduled commercial banks, while the regional rural banks and NBFCs are excluded.

Cash Reserve Ratio vs Statutory Liquidity Ratio

The objective of maintaining the cash reserve is to prevent the shortage of funds in meeting the demand by the depositor. The amount of reserve to be maintained depends on the bank’s experience regarding the cash demand by the depositors. If there had been no government rules, the commercial banks would keep a very low percentage of their deposits in the form of reserves. Increasing the percentage of deposits that banks must keep in the form of vault cash causes a decrease in the amount of lending that they are able to do.

Other liabilities could take the form of call money market borrowings, certificates of deposit, interest deposits in other banks, dividends, etc. Deposits where the depositor cannot withdraw deposits immediately or, rather, have to wait till they mature are Time deposits. These include fixed deposits, staff security deposits, and the time liabilities portion of the savings bank deposits. A country whose inflation is rising will typically experience a rise in its reserve ratio. An investor can hedge such risks by investing in multiple regions and countries. An investor can also shift his investments into areas that are not influenced by changes in the ratio.

Know the difference between CRR, Repo Rate, and Reverse Repo Rate in the linked article. Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.