What is the Cash Reserve Ratio (CRR)?
The share of total deposits of the bank, which is required to maintain with Central bank of the respective country is known as the cash reserve ratio and it is used as a means of controlling liquidity in the banking financial system.
In simple words, Cash Reserve Ratio (CRR) is a certain percentage of the total deposits of the bank that must be kept in the current account with the central bank of the country, which would mean that the bank shall not have access to that amount of money for any commercial activity or economic activity.
Formula
The 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 is referred to as the reserve amount, and the formula for expressing the same is :
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For eg:
Source: Cash Reserve Ratio (wallstreetmojo.com)
Where Bank Deposits will generally include the following:
Net Demand and Time liabilities, which is nothing but a summation of savings accounts, current accounts, and fixed deposits, which are held by the bank.
The equation for calculating the cash reserve ratio is quite simple in its nature.
- The first part is the reserve requirement, which is determined by the central bank of the country after considering all the macro factors that are occurring in the country that is the inflation rate, spending rate, demand and supply of the goods, trade deficitTrade DeficitWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.read more, etc.
- The second part of the formula is Net Demand and time deposits, which are borrowed by the bank in the form of deposits, and the central bank likes to keep a certain amount of reserve aside from all banks to survive during the financial crisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more.
Examples
Example #1
ABC bank ltd is registering itself as a bank for the first time with the central bank. It wants to determine its cash reserve requirement, and it has calculated its Net Demand and Time liabilities as $1 billion. You are required to calculate all the Cash Reserve Ratio, considering the reserve requirement is 5%.
Solution:
The central bank has determined a reserve requirement as 5%. Bank’s Net deposits are $1 billion.
So, the calculation of Cash reserve ratio equation can be done as follows-
- Reserve Ratio = Reserve Requirement * Bank Deposits
- = 5% * 1,000,000,000
Reserve Ratio will be
- Reserve Ratio = 50,000,000.
Hence ABC bank needs to keep $50 million in the current account with a central bank.
Example #2
Below is the extract from RBL bank ltd for two financial years. All the below figures are in crores. Assume that Net Demand and Time liabilities are 45% of the total borrowings, and Central bank requires a 4% reserve ratio.
You are required to calculate the cash reserve ratio for both years.
Solution:
The Central bank has determined the reserve requirement as 4%. And bank’s Net deposits are 45% of total borrowings.
- Bank Deposits for Mar 2017 = 42,567.85 *45% = 19,155.33
- Bank Deposits for Mar 2018 = 53,163.70 * 45% =23,923.67
So, the calculation of Cash reserve ratio as of Mar 2017 can be done as follows-
- Reserve Ratio = Reserve Requirement * Bank Deposits
- = 4% * 19,155.53
Reserve Ratio of Mar 2017
- Reserve Ratio = 766.22
Now, the calculation of Cash reserve ratio as of Mar 2018 can be done as follows-
- Reserve Ratio = Reserve Requirement * Bank Deposits
- = 4% * 23,923.67
Reserve Ratio of Mar 2018
- Reserve Ratio = 956.95
Example #3
Below is the extract from Federal bank ltd for two financial years. All the below figures are in crores. Assume that Net Demand and Time liabilities are 85% and 90% of the total borrowings and Central bank requires a 5% and 5.5% reserve ratio for the year 2017 and 2018, respectively.
You are required to calculate the cash reserve ratio requirement for both years.
Solution:
The central bank requires a reserve ratio to be 5% for 2017 and 5.5% for 2018. And bank’s Net deposit is 85% and 90% for 2017 and 2018, respectively, of total borrowings.
- Bank Deposits fo Mar 2017 = 103561.88 * 85% =88,027.60
- Bank Deposits for Mar 2018 =123525.99 * 90% =138533.14
So, the calculation of Cash reserve ratio as of Mar 2017 can be done as follows-
- Reserve Ratio = Reserve Requirement * Bank Deposits
- = 5% * 88,027.60
Reserve Ratio of Mar 2017
- Reserve Ratio = 4,401.38 crores
So, the calculation of the Cash reserve ratio formula of Mar 2018 can be done as follows-
- Reserve Ratio = Reserve Requirement * Bank Deposits
- = 5.5% * 111,173.39
Reserve Ratio of Mar 2018
- Reserve Ratio = 6,114.54 crores
Relevance and Uses
When banks source deposits from the public, the key goal of the bank is to lend and, in turn, to earn a spread. Banks may like to maximize their lending to maximize their profit and keep their idle cash sitting in the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more at a minimum. If most of the funds are lent out, and in case there is an emergency or say there is a sudden rush to withdraw funds, then the banks will struggle to meet their commitments or, in other words, their repayments.
Against those deposits, ensuring some liquid money is the main purpose of CRR, while its secondary objective is to allow the central bank to control rates and liquidity in the economy. Interest rates swing up or down in the short term depending upon how much of the liquidity is available for the banks to lend. Too much flow of money or spike in money lending will lead to a collapse in the rates, and too little will lead to a spike.
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