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Cash Reserve Ratio (CRR)

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(Created page with "<p>The Cash Reserve Ratio refers to the fraction of the total Net Demand and Time Liabilities (NDTL) of a Scheduled Commercial Bank held in India, that it has to maintain as ca...")
 
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<p>The Cash Reserve Ratio refers to the fraction of the total Net Demand and  
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<p>Cash Reserve Ratio refers to the fraction of the total Net Demand and  
 
Time Liabilities (NDTL) of a Scheduled Commercial Bank held in India, that it  
 
Time Liabilities (NDTL) of a Scheduled Commercial Bank held in India, that it  
 
has to maintain as cash deposit <i>with the Reserve Bank of India (RBI)</i>. The  
 
has to maintain as cash deposit <i>with the Reserve Bank of India (RBI)</i>. The  

Revision as of 05:50, 6 September 2011

Cash Reserve Ratio refers to the fraction of the total Net Demand and Time Liabilities (NDTL) of a Scheduled Commercial Bank held in India, that it has to maintain as cash deposit with the Reserve Bank of India (RBI). The requirement applies uniformly to all banks in the country irrespective of an individual bank’s financial situation or size. In contrast, certain countries e.g. China stipulates separate reserve requirements for ‘large’ and ‘small’ banks.

As per the RBI Act 1934, all Scheduled Commercial Banks (that includes public and private sector banks, foreign banks, regional rural banks and co-operative banks) are required to maintain a cash balance on average with the RBI on a fortnightly basis to cater to the CRR requirement. With effect from December 28, 2002 all banks are required to maintain a minimum of 70 per cent of the required average daily CRR on all days of the fortnight. Non Bank Financial Corporations (NBFCs) are outside the purview of this reserve requirement.

Traditionally, the amount held to cater to the CRR requirement was stipulated to be no lower than 3 percent and no higher than 20 percent of the total NDTL held in India. However, the RBI (amendment) Act, 2006 provides for removal of the floor and ceiling with respect to setting the CRR and authorizes the RBI to set the ratio in keeping with the broad objective of maintaining monetary stability in the economy.

Presently, banks are not paid any interest on behalf of the RBI for parking the required cash. If a bank fails to meet its required reserve requirements, the RBI is empowered to impose a penalty by charging a penal interest rate.

Historically, the CRR was mooted as a regulatory tool. However, over the years and especially after the liberalization of the Indian economy in the early 1990s, with the economy experiencing substantial inflows of capital exerting stress on the leverage of the central bank to manipulate liquidity conditions in the domestic money market, the CRR assumed importance as one of the important quantitative tools aiding in liquidity management. In contrast to the Liquidity Adjustment Facility (LAF), which aids liquidity management on a daily basis via changes in repo and reverse-repo rates, changes in the CRR is aimed at the same in the medium term.

The CRR was reduced from a level of 8.5 percent in August 2008 to 6 percent in September, 2008 to ease liquidity in domestic markets on the face of the global financial crisis. The cut continued through 2008 reaching a level of 5 percent in January 2009. The CRR was maintained at this level throughout 2009 and eventually raised to 6 percent in April, 2010.

A country that uses the CRR aggressively to control domestic liquidity and target the monetary roots of inflation is China. In the recent past the People’s Bank of China has frequently raised the reserve requirement for its banks primarily to rein in rising inflation. In the latest policy move, the Bank raised the required reserve ratio by 50 basis points, to 21.5 percent for large banks and19.5 percent for smaller ones, effective from June 20, 2011.

The RBI website (www.rbi.org.in) carries information on the prevailing policy rates including CRR. Presently the CRR stands at 6 percent. Various publications by the RBI, including monthly bulletins, discuss and analyze rationale behind changes and expected effects of CRR changes as and when the need arises.


References

“Central Bank Balances and Reserve Requirements”, Simon Gray, IMF Working Paper No. WP/11/36, February, 2011.</p>


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