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 of 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 form of liquid cash and it acts as a tool that is used by the central bank in order to control the liquidity in the banking system.
Objectives
Following are important objectives of CRR:
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Source: Full Form of CRR (wallstreetmojo.com)
- It is to regulate the money flow 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.
- Their policies help to maintain liquidity in the economy. Whenever the economy of a country faces a liquidity crunch, the cash reserve ratio is reduced by the central bank of the country. Because of this reason, the banks all around the country will be able to lend more money to the customers. Therefore, more money will be available to the general public to the expense and hence, liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.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 whole of the cash available with the banks some portion or the ratio of total cash available is reserved or set aside so that.
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 which the bank is required to maintain with the central bank.
- Bank Deposits = Bank deposits refer to the overall deposits of the bank.
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Source: Full Form of CRR (wallstreetmojo.com)
Example of CRR
Let’s take an example of a bank that has the total deposits of $1,500 billion 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 on December 31, 2019. Now, the Reserve requirement of the Federal Reserve i.e., cash reserve ratio is 9%. Calculate the bank’s cash reserve requirement for the year 2019.
Solution:
In the present case, it is given that as on December 31, 2019,
- Total deposits of bank = $1,500 billion
- Cash reserve ratio = 9%
Now according to the formula Reserve Requirement will be calculated as:
- Reserve Requirement = 1,500 * 9%
- Reserve Requirement = $135 billion
Thus the bank’s cash reserve requirement for the year 2019 is $135 billion.
Impact of CRR
The Cash reserve ratio has a direct impact on 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 rate of lending will rise and the expense of the borrowing will increase. On the other hand, banks will encourage people to provide more and more deposits and to attract them, the rate of the deposit will get 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 is required to 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
- Cash reserve ratio and statutory liquidity ratio are 2 different policies of the central bank, however, both are compulsory requirements of every bank.
- CRR is a certain percentage of total bank deposits which is required in the current account of the central bank. Bank has no access to this amount for any of the 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 that is 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 in maintaining 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 as well as 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 on the same.
- It reduces the lending capacity of the bank and hence it stops them to earn the maximum amount of profit.
Conclusion
CRR is the abbreviation used for Cash Reserve Ratio. It is the portion of the commercial bank’s total deposits which 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 the purpose of any of the commercial lending. It is a primary way of controlling the money supply in the economy.
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This has been a guide to the Full Form of CRR (Cash Reserve Ratio) and its meaning. Here we discuss examples of CRR along with impact, and differences between SLR and CRR. You may refer to the following articles to learn more about finance –
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