THE CRR RATIO

• It is a bank regulation that sets the minimum reserves each bank must hold byway of customer deposits and notes.

• These deposits are designed to satisfy each withdrawal demands of customers.

• Deposits are normally in the form of currency stored in a bank vault or with the Central bank like RBI.

• CRR is also called the liquidity ratio as it seeks to control money supply in the economy.

• CRR is used as a tool in monetary policy, in influencing the country’s economy, borrowing and interest rates.

• CRR works like brakes on the economy’s money supply.

• CRR requirements effect the potential of the banking system to create higher or lower money supply.

• For example say…the CRR is pegged by RBI at 10%... If a bank receives RS 1000 as deposit then they can lend Rs.900/-as a loan and will have to keep a balance of Rs.100/- in the customers deposit account.

• Now a borrower who received Rs.900/- as a loan will deposit the same in his bank.

• The borrower bank will now lend out Rs.810/- and keep Rs.90/- in his deposit account.

• As this process continues, the banking system can expand the initial deposit of Rs.1000/- into a maximum of Rs.10000/- ( Rs.1000+Rs.900+Rs.810...= Rs.10000).

• The higher the CRR ratio the lower the money available for lending.

• This reduces the credit expansion by controlling the amount of money that goes out by way of loans.

• This directly effects money creation process and in turn effects economic activity.

• CRR is increased to bring down inflation which happens due to excessive spending power.
• Spending

• Spending power is augmented by loans-If the money goes out s loans is controlled, inflation can be tamed to some extent.

• A lower CRR allows the bank to lend more money and will fuel consumption and spending.

• Conversely, if the government wants to stimulate higher economic activity and encourage higher spending to achieve economic growth, they will lower CRR.

• Thus banks indirectly enjoy the power to create more money