CRR stands for Cash Reserve Ratio. In India, banks are supposed to keep aside certain proportion of deposits in the form of cash. This amount is stipulated by the Reserve Bank of India and is called as the Cash Reserve Ratio.
Let us go into detail. Indian banks are required to keep certain amount of deposits in the form of cash. But they do not hold this cash with themselves. In practice, the banks deposit this cash with RBI. Depositing into RBI is equivalent to cash holding with itself. But this amount of deposit is decided by the RBI. It is known as Cash Reserve Ratio.
How do you plan your budget? You spend for the essential commodities, pay your utility bills, and spend on shopping your desires and you invest. But do you spend and invest all the money and do not maintain a balance in your savings account? Well, the crux is you ensure that you are holding certain amount of cash in the savings bank account. This cash can be withdrawn in the case of emergency or for purchasing anything. Thus, you do not spend all the cash or do not invest the entire amount. This same applies to the commercial banks. They also keep certain cash with RBI. But please note that this amount is stipulated by the RBI itself.
CRR and liquidity in the banking system
The CRR is utilized for managing liquidity in a banking system. Let us consider an example. If the bank deposits increase by Rs.100, and the RBI has formulated a CRR of 9% for all the banks. Here, the bank is required to hold Rs. 9 with Reserve Bank of India. Rest of the deposit that is Rs. 91 is utilized for investing and lending purpose. This infers that if the CRR is higher, then the banks can utilize fewer amounts for lending and investment purposes. The Reserve Bank of India has the authority to lessen the amount to be lent by increasing the cash reserve ratio. Thus, RBI can control the lendable amount with the help of CRR. It is used as an important monetary tool for controlling the liquidity in the banking system.
Importance of CRR for banks
CRR refers to the specified minimum amount from the total deposits to be held as reserves with the Reserve Bank of India. CRR is set according to the guidelines of Reserve Bank of India. This amount is either stored in cash or cash equivalents. If the banks run out of cash for meeting the payment requirements of the investors, then this need is met by the CRR. The money supply in an economy is controlled by CRR. The commercial banks cannot spend their cash in lending the customers. They are required to hold certain amount as CRR with the Reserve Bank of India.
Thus, it is necessary to understand CRR by a layman. We often come across the terms such as CRR and repo rate but are not much familiar with its meaning.