Full Form Of Crr Cash Reserve Ratio Objectives Examples Impact

Full Form of CRR – Cash Reserve Ratio

The full form of CRR is the Cash Reserve Ratio. CRR refers to the share of the total deposit by the commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.read more which they have to keep with the central bank in the form of liquid cash, and it acts as a tool used by the central bank to control liquidity in the banking system.

Objectives

Following are important objectives of CRR:

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It is to regulate the money flowMoney FlowMoney flow (MF) refers to a mathematical function used to analyze changes in the value of a security by multiplying its typical price by daily trading volume.read more in the economy. The CRRCRRCash Reserve Ratio refers to the share of a Bank’s total deposits that need to be maintained with the respective Country’s Central Bank to control financial supply in the economy. read more policy of the central bank determines how much the money will flow in the whole economy.These policies help to maintain liquidity in the economy. Whenever a country’s economy faces a liquidity crunch, the cash reserve ratio is reduced by the country’s central bank. Incidentally, banks all around the country can lend more money to customers. Therefore, more money will be available to the general public for expenses, and hence, liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more issues will be balanced in the economy.They make sure that the banks maintain the solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more position. Rather than lending out the total cash available with the banks, some portion of the ratio of total cash available is reserved or set aside.

CRR Formula

The following is the formula to calculate the Cash reserve ratio:

Where,

Reserve RequirementReserve RequirementReserve Requirement is the minimum liquid cash amount in a proportion of its total deposit that is required to be kept either in the bank or deposited in the central bank, in such a way that the bank cannot access it for any business or economic activity.read more = Reserve requirement refers to the cash reserve that the bank must maintain with the central bank.Bank Deposits refer to the overall deposits of the bank.

Example of CRR

Let’s take an example of a bank with total deposits of $1,500 billion in its annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more as of December 31, 2019. Now, the reserve requirement of the Federal Reserve, i.e., the cash reserve ratio, is 9%. So, calculate the bank’s cash reserve requirement for the year 2019.

Solution:

In the present case, it is given that as of December 31, 2019,

Total deposits of bank = $1,500 billionCash reserve ratio = 9%

Now according to the formula, the reserve requirement will be calculated as:

Reserve Requirement = 1,500 * 9%Reserve Requirement = $135 billion

Thus, the bank’s cash reserve requirement for 2019 is $135 billion.

Impact of CRR

The cash reserve ratio directly impacts the interest rate in the economy. If the central bank increases the CRR requirements of the bank, then it will lower the lending requirement of the bank; therefore, it will not be able to lend more, and hence the rule of demand and supply will apply here. With lower lending capacity, the lending rate will rise, and the expense of borrowing will increase. On the other hand, banks will encourage people to provide more and more deposits and attract them; the deposit rate will be reduced. Therefore, the interest rate in the economy will fluctuate.

Importance of CRR

The cash reserve ratio lays a foundation for the better functioning of the banking industry. The following are the main importance of the Cash Reserve Ratio:

The CRR ratio is the minimum proportion of the cash reserve that a bank will need to set aside to maintain the required amount of solvency.It is a very small portion of liquid funds against all the bank deposits.It helps the central bank to administer the rate and the average overall amount of liquidity in the entire country.It is the right portion of the money that a bank must set aside. Based on the rate of inflationRate Of InflationThe rate of inflation formula helps understand how much the price of goods and services in an economy has increased in a year. It is calculated by dividing the difference between two Consumer Price Indexes(CPI) by previous CPI and multiplying it by 100.read more and money flow in the economy, it is determined and is changed from time to time as per the need in the economy.

Difference between CRR and SLR

The cash reserve ratio and statutory liquidity ratioStatutory Liquidity RatioThe statutory liquidity ratio (SLR) is the minimum percentage of liquid assets that every commercial bank needs to retain. It acts as a reserve and comprises cash, securities, and gold.read more are two different central bank policies. However, both are compulsory requirements for every bank.CRR is a certain percentage of total bank deposits required in the central bank’s current account. Banks have no access to this amount for any economic or commercial activity, and a bank can not lend this money to any lenders; neither can they use it for investment purposes.On the other hand, SLR is the money invested in various specified securities of the central government. It is a certain percentage of the total bank deposit. Banks can earn interest on SLR investment as against CRR.

Advantages

The following are the benefits of the Cash Reserve Ratio:

It is a primary way of controlling the money supply in the economy. The strong and competitive money supply of the economy will help maintain a strong credit system.Commercial banks can maintain a good solvency ratioSolvency RatioSolvency Ratios are the ratios which are calculated to judge the financial position of the organization from a long-term solvency point of view. These ratios measure the firm’s ability to satisfy its long-term obligations and are closely tracked by investors to understand and appreciate the ability of the business to meet its long-term liabilities and help them in decision making for long-term investment of their funds in the business.read more for commercial and other banks.Whenever there is a surplus money situation in the economy, funds can be easily migrated through CRR.

Disadvantages

The following are the disadvantages of the Cash Reserve Ratio:

A frequent change in the CRR may adversely affect a healthy economic environment.It is the amount set aside in the current account of the central bank. Hence banks don’t earn any interest on the same, not even gain the inflation portion.It reduces the bank’s lending capacity and stops them from earning the maximum profit.

Conclusion

CRR is the abbreviation used for Cash Reserve Ratio. The portion of the commercial bank’s total deposits is compulsory for it to maintain with the country’s central bank in the form of the cash reserve. Out of this reserve requirement, money cannot be used for any commercial lending. Therefore, it is a primary way of controlling the money supply in the economy.