When you deposit your money in a bank have you ever wondered what happens to that money? No, it’s not just stored; the bank utilizes your money to give it to other people who come to ask for loans. Now suppose this happens with twenty other customers and suddenly all these customers come to the bank in order to withdraw their money. In this case, the bank will surely be out of money as it would have given most of the people’s money out as loan. To prevent this from happening, the central bank of a country, which is the Reserve Bank Of India for our country, instructs banks to maintain a Cash Reserve Ratio or CRR. If you wish to enhance your banking awareness then in this module we seek to explain the meaning of CRR and the way it impacts the economy or money markets.
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Banking Awareness: What is C.R.R.?
C.R.R. or Cash Reserve Ratio is the minimum amount that all the commercial banks need to maintain with the central bank of a country (in case of India it is the RBI). This is done by the central bank in order to ensure that the banks don’t run out of money when the depositors come asking for their money. The CRR is maintained as per the guidelines given by the central bank.
The Cash Reserve Ratio is a crucial monetary tool and is used by the government to control the money supply in an economy. In addition to this, the CRR also gives the central bank greater control over money supply.
For example suppose a person deposits Rs. 10,000 in the bank and the Cash Reserve Ratio is the bank is 4%. In this case, the bank must keep 4% of 10,000 which is Rs.400 with the RBI and the rest Rs. 9,600 can be used by the bank to lend to others.
Impact of C.R.R. on Economy
When C.R.R. is decreased:
When the Cash Reserve Ratio is decreased, it enables the bank to give out more loans since they can keep more money with themselves. When the loans are given out at a lower rate of interest, more people will be interested in taking loans which will lead to more businesses and investments thus giving a boost to the economy. However, excessive taking of loans may also lead to inflation.
When C.R.R. is increased:
When the Cash Reserve Ratio is increased, the banks will have to deposit more money with the central bank. This will mean that the banks can give lesser money as loans and thus the rate of interest on loans may increase. Once the availability of loans is decreased, less people would be induced to raise money through loans and it would be costlier to start up new businesses or investments. Thus, the economy will slow down as people will wait for the rate of interest on loans to decrease.
Increasing the cash reserve ratio also helps the government in tackling the problem of Inflation as once the C.R.R. is increased; the money supply in the economy is decreased. Less money supply will mean less demand and once the demand for the commodity is less, the price will automatically come down.
Thus, the cash reserve ratio is a very important monetary tool which is used to control money supply in an economy and to control inflation. Since it is an important concept of the banking world, it also is an important part of banking awareness.