Cash reserve ratio (CRR) is a statutory provision in India regulated by RBI under Section 42(1) of the Reserve Bank of India Act 1934. According to the above section, every scheduled bank in India needs to hold on a certain percentage of cash without being allowed to invest or lend it for interest.
The Cash reserve of the banks is either stored in the bank’s vault or at the RBI the Central Bank of the country. Banks don’t earn any interest on that money.
The percentage of money to be held under CRR shall not be less than 3 percent of the Net demand and time liabilities (NDTL) of the bank. Apart from the above minimum balance of the Cash Reserve Ratio, RBI is empowered to increase it by notification up to 15 percent under the Act. At present CRR to be maintained by banks in India is 4.5%.
Illustration:
The present CRR is 4.5%, and then banks must put aside INR 4.5 every time there is an increase in their deposits by INR 100. And this equation must be maintained within a fortnight.
In technical terms, the cash reserve ratio (CRR) is calculated as a percentage of net demand and time liabilities (NDTL). So, the formula for CRR is
CRR = (Cash/NDTL) x 100. This has to be revisited every fortnight and ensure that CRR is maintained at 4.5 percent.
Every scheduled bank, small finance bank, and payments bank shall maintain a minimum CRR of not less than ninety percent of the required CRR on all days during the reporting fortnight, in such a manner that the average CRR maintained daily shall not be less than the CRR prescribed by the Reserve Bank.
In order to improve cash management by banks, as a measure of simplification, a lag of one fortnight is allowed for banks to maintain CRR based on the NDTL of the last Friday of the second preceding fortnight.
Also, the proportions of demand and time liabilities so obtained for each half year shall be applied for arriving at demand and time liabilities components of savings bank deposits for all reporting fortnights during the next half year.
Purpose of CRR:
RBI tries to curb inflation by increasing the CRR, wherein banks have to keep more balance with RBI, thus their lend-able resource depletes. The depleted lend-able resource of banks has a direct effect on the economy. When banks lend less, the money supply in the economy becomes scarce; naturally, the demand for money goes up. The demand for more money due to the increase in CRR by RBI along with other regulatory actions such as increasing the SLR limit, bank rate, repo rate, etc., helps in curbing inflation. There will be a vice versa effect when RBI cuts the CRR rate, to encourage bank lending, thereby more credits available to Industries and other entrepreneurs, thus accelerating economic activities.
NDTL for banking refers to the aggregate savings account, current account, fixed deposit balances, and other demand liabilities, etc. of the bank. Read the below-linked post to know how NDTL for banks is calculated.
