CASH RESERVE RATIO (CRR)

1. Context

The Reserve Bank of India’s three-day monetary policy review started on (December 4). Although there seems to be a broad consensus that the repo rate — the rate at which RBI lends to other banks — is likely to remain unchanged at 6.5 per cent, there is an expectation that the central bank may announce a cut in the cash reserve ratio (CRR).

2. What is the Cash Reserve Ratio(CRR) ?

The Cash Reserve Ratio (CRR) is the percentage of a commercial bank's total deposits that it is required to keep as reserves in the form of cash with the Reserve Bank of India (RBI). The banks are not allowed to use this reserved amount for lending or investment purposes.

The Cash Reserve Ratio (CRR) represents the portion of a bank’s total deposits that must be held as liquid cash with the Reserve Bank of India (RBI). The RBI periodically determines the CRR rate, which is currently set at 4.5%. Banks do not earn interest on this reserve amount.

While the Monetary Policy Committee (MPC) is responsible for decisions related to the repo rate and policy stance, the RBI independently manages liquidity measures.
Analysts suggest that the RBI might lower the CRR by either 25 basis points (bps) or 50 bps. (Note: One basis point equals 0.01%). If implemented, this would mark the first reduction in over 4.5 years.
To curb rupee volatility resulting from sustained Foreign Portfolio Investor (FPI) outflows and the strengthening of the US dollar, the RBI has been actively selling dollars in the foreign exchange market

3.What will be the impact of a CRR cut?

If the RBI reduces the Cash Reserve Ratio (CRR) by 50 basis points (bps), it would release approximately ₹1.10 lakh crore to ₹1.2 lakh crore in bank liquidity currently held with the central bank. A smaller cut of 25 bps would make around ₹55 crore to ₹60 crore available to banks.

This additional liquidity could be utilized by banks to enhance lending, which in turn would support economic growth.
The RBI last reduced the CRR during the COVID-19 pandemic in March 2020, lowering it from 4% to 3% on March 28, 2020, after maintaining it unchanged for seven years. Since then, the CRR has been increased three times, with the most recent revision to 4.5% on May 21, 2022

4. Statutory Liquid Ratio (SLR)

The Statutory Liquidity Ratio (SLR) is the minimum percentage of a commercial bank's Net Demand and Time Liabilities (NDTL) that it must maintain in the form of liquid assets, such as cash, gold, or government-approved securities. The SLR is a requirement set by the Reserve Bank of India (RBI) and is part of the monetary policy framework to regulate inflation and ensure the stability of the banking system

Composition of Liquid Assets:

The assets that banks can use to maintain the SLR include:
- Cash
- Gold
- Government bonds and securities (mainly government-approved bonds).

5. CRR vs SLR

Feature	SLR (Statutory Liquidity Ratio)	CRR (Cash Reserve Ratio)
What is maintained	Liquid assets (cash, gold, government securities)	Cash reserves with RBI
Earnings	Earns interest on government securities	No interest earned
Regulation	Regulated by the RBI for liquidity control	Regulated by the RBI for inflation control
Impact on Lending	Higher SLR means less funds available for lending	Higher CRR means less funds available for lending

6. Why do banks have to reserve cash with RBI?

Since a portion of a bank's deposits is held with the Reserve Bank of India (RBI), it ensures the safety of the funds in case of emergencies, making the cash available when customers withdraw their deposits.
During periods of high inflation, the government aims to prevent excess money from circulating in the economy. The Cash Reserve Ratio (CRR) plays a role in controlling inflation.
When there is a risk of high inflation, the RBI raises the CRR, requiring banks to hold more money in reserves, which reduces the amount available for lending and slows down the flow of money in the economy.
On the other hand, when the need arises to inject funds into the economy, the RBI may reduce the CRR.
This allows banks to lend more to businesses and industries, fostering investment and boosting economic growth. Lower CRR also contributes to accelerating the growth rate of the economy

For Prelims: Economic and Social Development

For Mains: General Studies III: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Previous Year Questions

1.Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (UPSC CSE 2017)

1. It decides the RBI’s benchmark interest rates.
2. It is a 12-member body including the Governor of RBI and is reconstituted every year.
3. It functions under the chairmanship of the Union Finance Minister.

Select the correct answer using the code given below:

(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 2 and 3 only

Answer (a)

It decides the RBI’s benchmark interest rates:
This statement is correct. The Monetary Policy Committee (MPC) is responsible for setting the benchmark interest rates, such as the repo rate, which influence borrowing and lending rates in the economy.
It is a 12-member body including the Governor of RBI and is reconstituted every year:
This statement is incorrect. The MPC consists of 6 members (not 12). It includes the Governor of the RBI and the Deputy Governor of the RBI, along with three other members appointed by the government of India. The committee is reconstituted every three years, not annually.
It functions under the chairmanship of the Union Finance Minister:
This statement is incorrect. The MPC is chaired by the Governor of the RBI, not the Union Finance Minister.

Thus, the correct answer is (a) 1 only

Source: Indianexpress

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CASH RESERVE RATIO (CRR)

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