Blog

What is Cash Reserve Ratio and How it Works?

Submitted by admin on September 19th, 2024

A Bank has a huge sum as deposits, but not all the money stored by the bank is in the same form. Some part of this deposit is kept in the form of liquid cash and this amount which is readily available is known as the Cash Reserve Ratio or CRR. This is not maintained by the bank itself, as it is the RBIs requirements for banks, so RBI stores this reserve cash.

This amount is not used by either the RBI or the banks, as they cannot use it to earn interest, or use it for investing or lending. Therefore, when CRR is low, banks have better chances of offering more as loans, which then improves economic growth.

Why does CRR exist?

By implementing CRR, the RBI ensures that banks always have a certain amount of its assets liquidated. By doing this even when there is a rapid increase in demand, banks always have funds readily available as a reserve. When inflation increases, people try to borrow more from banks to meet their needs. However, if banks lend at this time, they will face loss later one, so in order to control this the Central Reserve Ratio is increased to lower the amount banks can lend to people. This keeps the inflation rate in check and dissuades banks and people from creating more loans at this time.

Why is Cash Reserve Ratio important?

Listed below are some important reasons why CRR is important.

Monetary policy tool: This system is an effective tool for the Reserved Bank, so that it can effectively control and limit flow of money in adverse situations so that it is easy to achieve economic objectives.

Liquidity: Liquidating assets always takes some time. Therefore, by holding some liquidated assets there is certain stability as banks do not have to face losses by liquidating urgently.

Control inflation: Cash Reserve Ratio is used for controlling debts especially in times of inflation. During inflation, with prices rising people try to take more as loans and by lending more it puts the banks as well as the economy at risk.

Failure prevention: A certain percentage of the entire deposits at the bank are safeguarded, this ensures that banks have this fund readily available in adverse conditions. So that there is no risk of financial failure of a bank.

Safeguarding consumer deposits: Not only does the bank remain safe and functional due to CRR, consumer deposits also remain safe. If the bank does not lend more than it should, it automatically protects its consumer’s deposits.

CRR does play a major role in safeguarding banks and the economy from collapsing in times of increasing inflation rates. However, it is not just CRR which does this but a combination of monetary policies implemented by central banking systems which are implemented or modified according to current economic situations.

If you want to know more about CRR and understand how it affects your deposits in your banks, get in touch with experts at Dailyfinserv to ensure, your financial situation remains stable.