Cash Reserve Ratio is a certain percentage of the bank’s total deposits that banks must maintain with the Reserve Bank of India in the current account. Banks do not have access to this money for any commercial or business activities. If the RBI decides to hike CRR, funds available with banks for disbursal of loans and daily transactions diminish.
CRR is one of the most commonly used tools for credit control. Commercial banks must maintain an average cash balance with the RBI, which should not be less than 3% of total Net Demand and Time Liabilities (NDTL) on a fortnightly basis. So, we can say that CRR is a tool used by the central banks to control liquidity in the banking system.
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SEE ALSO: What is CRR?
The objectives of CRR are as follows:
The most important part of the calculation of CRR is Demand and Time Liabilities (DTL). DTL can be defined as the total volume of liabilities for which the banks must maintain CRR with the RBI. DTL encompasses time liabilities of the bank like current account deposits, savings account deposits, margins held against L/Cs and guarantees, outstanding TT/MT/DD and call money borrowings.
Time liabilities of the bank include fixed deposits, cash certificates, recurring deposits and so on. However, DTL does not include loans from RBI, refinance from NABARD/NHB, income tax provisions, unrealized gains or losses from any derivative transactions.
Banks must maintain a certain percentage of deposits as CRR with the RBI. Currently, all banks must maintain 4% of deposits that must be held in a current account with the RBI (CRR is 4%). When the cash reserve ratio is lowered by the RBI, banks have surplus money to invest in other businesses as the cash reserves needed to be maintained with RBI is low. When there is an increase in money supply, excess funds lead to inflation in the economy. RBI immediately increases the CRR to flush out excess funds in the economy. CRR is a monetary tool to control the overall liquidity in the banking system. Failure to maintain the minimum CRR leads to imposition of penalties on banks.
CRR balance is a percentage of the total demand and time liabilities of the bank maintained with RBI. Higher the CRR, lower will be the liquidity in the system. The RBI is empowered to change CRR from 3% to 15%. Funds are maintained as reserves with the RBI for helping banks during an emergency. These deposits do not earn interest. RBI increases CRR as a policy to reduce bank’s liquidity and it reduces CRR when it wants to increase liquidity in the banking system and boost credit.
Cash Reserve Ratio is revised by the RBI from time to time. It is part of the statutory reserves stipulated by the RBI. Statutory reserves include the CRR and the statutory liquidity ratio (SLR). The CRR is maintained with the RBI to ensure banks have sufficient liquidity in order to carry out daily transactions and bank withdrawals of customers. CRR plays an important role in the functioning of the banking system. It also helps banks maintain solvency and liquidity positions.
SEE ALSO: How is CRR Calculated?
Repo rate is the rate at which the RBI lends to banks against government securities. Repo rate is an instrument of monetary policy. Whenever there is a shortage of funds, commercial banks borrow money from the RBI and have to pay interest on the money borrowed. The rate of interest on the borrowed funds is known as repo rate. Repo rate is currently 6.25%. A reduction in repo rates helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the USA.
Reverse repo rate is the rate at which the RBI borrows money from the commercial banks. Banks easily lend to the RBI as they know that the money is in safe hands. Banks earn interest by lending to the reserve bank of India. Currently the reverse repo rate is 6%. An increase in the reverse repo rate enables banks keep more money with the RBI and earn good interest and get better returns on surplus deposits. Reverse repo rate is also a monetary tool used by the RBI to control the flow of money in the economy by draining excessive liquidity out of the banking system.
Listed below are the main differences between repo rate and reverse repo rate. The differences help you get a better understanding:
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