The Cash Reserve Ratio is the amount of funds that the banks are bound to keep with Reserve bank of India, with reference to the demand and time liabilities (NDTL) to ensure the liquidity and solvency of the Banks. Please note that earlier RBI was empowered to fix RBI between 3-20% by notification. However, from 2006 onwards the RBI is empowered to fix the CRR on its discretion without any ceiling. The CRR is maintained fortnightly average basis.
What is impact of reducing CRR?
When CRR is reduced, more funds are available to banks for deploying in other business as they have to keep fewer amounts with RBI. This means that the banks would have more money to play and this leads to reduction of interest rates on Loans
provided by the Banks.
What is impact of Hiking CRR?
RBI uses the method of CRR hike to drain out the excess liquidity from the banks. This is because; the banks will now have to keep more money with the Reserve Bank of India. On this money banks don`t earn any / much interest. Since they don't earn any interest, the banks are left with an option to increase the interest rates. If RBI hikes this rate substantially, banks will have to increase the loan interest rates. The home loans, car loans and EMI of floating Rate loans increase.
The following Graphic shows the history of CRR since 2000.
The above graphic shows that RBI has used this tool to contain the money supply and credit creation more frequently. Highest CRR was 9% when the Global Financial Slowdown had started taking definite shape. During the slowdown years the CRR was reduced gradually so that Banks have more money with them. Once, the signs of recovery are shown clearly, RBI made it again a little higher.