Cash Reverse Ratio (CRR)

All banking institutions in India are required to hold a certain fixed proportion of the sum total of their deposits in the form of cash, with the country’s apex banking institution, the Reserve Bank of India. This percentage of assets maintained in the form of cash is referred to as the cash reserve ratio. It is utilised by the RBI to regulate liquidity in the banking industry.

As per the basis of the recent hike in the CRR ratio in May 2022, India's current cash reserve ratio is pegged at 4.50%. In simple terms, this means that if a bank receives deposits worth Rs. 100, it must maintain Rs. 4.5 in the form of cash deposits with the Reserve Bank of India. The CRR ratio is also a good sign for customers, indicating that irrespective of the bank’s financial status, a certain portion of their holdings remains safe with the Reserve Bank of India.

The cash reserve ratio has been formulated with the following purposes in mind:

• Maintaining Liquidity: Given that the RBI is the apex banking institution in the country, it is tasked with maintaining the levels of liquidity in the banking industry. If the RBI decides that it needs to infuse a higher dose of liquidity into the banking system, it will reduce the CRR ratio, and if it decides to reduce the liquidity in the banking system, it will increase the CRR ratio.

• Maintaining Bank’s Health: Given that all banks in the country are required to maintain a certain proportion of their funds in the form of cash holdings with the RBI, they can access these funds when customers make large withdrawals. The main aim of the cash reserve ratio is to protect banks so that they do not exhaust their stockpile of cash to meet customers’ demands.

• Setting of the Repo Rate: The RBI, being the apex banking institution, is also tasked with the responsibility of setting the repurchase rate, also referred to as the repo rate. This refers to the rate at which the RBI lends to commercial banks in the country. When it decides to increase the amount of liquidity in the market, it lowers the repo rate and vice-versa. To curb inflation, the RBI often resorts to increasing the repo rate.

Now that we have familiarised ourselves with the cash reserve ratio let us understand how it is calculated. If, for the sake of an example, the cash reserve ratio is 8%, then for every Rs. 1000 deposited with a bank, the bank will have to store Rs. 80 with the RBI in the form of cash reserves. Thus, this means that this leaves the bank with only Rs. 920 of the total deposit, for other purposes of lending. The amount saved as the CRR ratio cannot be used for the purpose of lending by the RBI, or any bank in the country.

To put the CRR ratio in terms of a formula:

CRR = (Liquid Cash/Net Demand and Time Liabilities) * 100

(Here, NDTL refers to deposits of various natures)

If the RBI decides to increase the CRR ratio, the funds available to banking institutions in the country come down. Thus, the RBI uses the CRR ratio to reign in the flow of money in India. As a mandate, the amount of deposits stored in the form of cash with the RBI should at no point be less than 4% of the Net Demand and Time Liabilities (NDTL) and is revised every fortnight.

NDTL here refers to all forms of deposits with banks. When we speak of demand deposits, we refer to all liabilities that banks possess, such as current deposits, demand drafts, balances of overdue fixed deposits, as well as demand liabilities.

When we refer to time deposits, we are speaking of deposits that are due for payment on maturity, wherein the depositor must wait out the stipulated time period before he/she can withdraw the said funds. This covers fixed deposits, staff security deposits, and the time liability portion of savings bank deposits.

Thus, NDTL= Demand and Time Liabilities with banks – Deposits with other banks

One of the most vital tools at the disposal of the RBI to affect its monetary policy, the cash reserve ratio is used to curb inflation and regulate the amount of liquidity in the market. When the cash reserve ratio is raised, there is lesser liquidity available with banks in the country, and the other way around.

When the level of inflation increases, the RBI increases the CRR ratio, thus reducing the amount of money that banks can lend to customers. Thus, this limits the economy's growth by reducing the supply of money and bringing down inflation rates.

Conversely, when the RBI reduces the CRR ratio, a larger sum of money is pumped into the economy, allowing banks to sanction more money as loans to customers. This thus gives impetus to the growth and expansion of the economy.

Like the CRR ratio, we have the SLR ratio or the Statutory Liquidity Ratio. This metric defines the amount of deposits that commercial banks in India have to maintain with the RBI in the form of gold, cash, and other such securities. Like the CRR ratio, the RBI uses the SLR ratio to curb inflation (by increasing the SLR ratio) and boost economic growth (by reducing the SLR ratio).

The key differences between the CRR ratio and the SLR ratio are as listed below:

Whenever the RBI decides to alter the cash reserve ratio, this is done with the intention to impact the economy. By way of the cash reserve ratio, the RBI can ensure that all commercial banks in the country do not exceed the amount lent to customers without setting aside sufficient cash for themselves. In addition to ensuring this liquidity against deposits, the cash reserve ratio is also utilised to control the rates of interest prevailing in the market. If there is an excess amount of cash circulating in the market, then the RBI will increase the interest rate to reduce inflation. If the RBI wishes to further expand the growth of the economy, it will reduce the interest rate. 

In addition to the CRR ratio and the SLR ratio, the RBI also makes use of the repo rate, and the reverse repo rate, to regulate the amount of money circulating in the economy. Changes in these rates significantly impact house loans online – directly affecting the Marginal Cost of Funds Based Lending Rate (MCLR). This is the factor that helps commercial banks determine how much interest they can charge on loans.