What is CRR - Cash Reserve Ratio?

The Cash Reserve Ratio (CRR) is a monetary policy tool used by the Reserve Bank of India
(RBI) to regulate commercial banks' liquidity and lending capacity. CRR refers to the portion
of a bank's total deposits that it must maintain with the central bank in cash reserves. It is a
percentage of the bank's net demand and time liabilities.
o Under the Reserve Bank of India Act of 1934, The Reserve Bank of India can set the
Cash Reserve Ratio (CRR).
o The amount of the cash reserve ratio can be transmitted to the Reserve Bank of India,
but it must be kept as a reserve in the commercial bank's vault and can take the form
of cash or anything that can be used to replace cash.
o The Monetary Policy Committee of The Reserve Bank of India, which typically meets
every two months, decides the percentage of cash reserve ratio that each commercial
bank must maintain.
Major Components of Repo Transaction
The following are some of the major components of the Repo Transaction that are important
for the RBI's approval to carry out any transaction with the banks:
o Avoiding economic squeezes: Depending on the inflation, the Reserve Bank of India
can raise or lower the repo rate, controlling the nation's economy in the process.
o Short-Term Borrowing: The RBI may make a short-term loan to commercial banks as
long as those institutions are required to buy back their depository securities at a
predetermined price.
o Buyer and Seller: The two main parties involved in a repo transaction are the buyer
(often referred to as the repo lender) and the seller (often called the repo borrower).
The buyer purchases the securities from the seller, while the seller agrees to
repurchase them at a predetermined price and date.
o Securities & Collateral: The RBI also accepts collateral in the form of gold and bonds.
o Liquidity: The money that the banks borrow from the RBI is kept on hand as a safety
measure to sustain liquidity
Importance of the CRR - Cash Reserve Ratio
o The main significance of the Cash Reserve Ratio (CRR) is to ensure that the banks do
not run out of money because of over-borrowing to their customers.
o If the CRR is set low by the Reserve Bank of India, the amount of liquidity of money
or the amount of cash available with the bank increases, which ultimately invests it in
various aspects like borrowing from the customers.
o This increases the risk of higher Non-Performing Assets (NPAs).
o However, a very high level of CRR can also negatively impact a nation's economy as
it lowers the amount of money available to commercial banks, which they can lend to
their customers.
 o Thus, this ultimately reduces the amount of spending and investment in an economy.
o CRR also plays the role of controlling the supply of money and the inflation level in
an economy.
o Suppose the level of inflation is high, which means that the liquidity of money is also
high. In that case, the Reserve Bank of India enhances the cash reserve ratio
percentage, ultimately reducing the amount of money the commercial banks can lend
to their customers.
o This finally reduces the liquidity of money in an economy and thus reduces inflation.
o In turn, when the level of inflation is low, which means that the liquidity of money in
an economy is also low, then the Reserve Bank of India reduces the cash reserve ratio
percentage, which enhances the amount of money available with the commercial
banks which they can use to lend more to their customers.
What is Repo Rate?
The Repo Rate is a key monetary policy tool central banks use to regulate an economy's
liquidity, money supply, and interest rates. It is the rate at which the central bank lends short-
term funds to commercial banks against eligible securities, such as government bonds or
treasury bills.
o The real meaning of the word ‘Repo’ means ‘Re-purchasing Option’ or the
‘Repurchase Agreement.’
o Under this mechanism, the commercial banks consent to the Central Bank's right to
repurchase the securities at a future date for a predetermined price typically greater
than the initial price.
o The Reserve Bank of India has the final say on the repo rate in that country.
Importance of Repo Rate
o Any fluctuation in the repo rate has a direct impact on the economy of a nation.
o When inflation is high, which means that the liquidity of money is also high, then the
Reserve Bank of India increases the repo rate, automatically reducing the amount of
money available with the commercial banks as they have to pay higher interest to the
Reserve Bank of India.
o This reduces their capacity to lend to their borrowers, which automatically reduces the
level of spending, thereby reducing the liquidity of money in the economy.
o Similarly, when the inflation rate is low, which means that the liquidity of money in
the economy is also low, then the Reserve Bank of India reduces the repo rate, which
ultimately increases the amount of money available to the commercial banks which
they can lend to their borrowers.
o Thus, this automatically enhances the level of spending and the liquidity of money in
that economy.
What is Statutory Liquidity Ratio (SLR) Rate?
The Statutory Liquidity Ratio (SLR) is a regulatory requirement imposed by the central bank
on commercial banks in certain countries, including India. It mandates that a certain
percentage of a bank's net demand and time liabilities (NDTL) be maintained through
specified liquid assets, such as cash, gold, or approved government securities. The SLR rate
is the percentage of NDTL that banks must keep as liquid assets. It is set by the central bank,
such as the Reserve Bank of India (RBI), in the case of India.
Working of Statutory Liquidity Ratio (SLR)
o By the end of the day, each bank must have a specific amount of its Net Demand and
Time Liabilities (NDTL) in cash, gold, or other liquid assets.
o The Statutory Liquidity Ratio is the ratio of these liquid assets to the demand and time
liabilities (SLR). This ratio may be raised by up to 40% at the discretion of the
Reserve Bank of India (RBI).
o An increased ratio hampers the bank’s capacity to inject money into the economy.
o For the Indian economy to function, the RBI is also in charge of controlling the
movement of money and maintaining price stability.
o Therefore, SLR is crucial in safeguarding the banks’ viability and the economy’s cash
flow, among other tools.
Importance of the Statutory Liquidity Ratio (SLR)
o To prevent commercial banks from over-liquidating: When the Cash Reserve Ratio
increases and the bank desperately needs money, over-liquidation might occur without
SLR.
o SLR regulation is a tool used by RBI to manage bank credit. SLR makes ensuring that
commercial banks are solvent and that they invest in government securities.
o To change the direction of the flow of bank credit: In periods of inflation, the Reserve
Bank of India increases SLR to limit bank credit. Similarly, it lowers SLR during a
recession to boost bank credit.
o Maintaining the base rate, also known as the minimum rate, at which Indian lenders
can grant loans to their clients is one of the key functions of SLR.
o SLR significantly contributes to increasing transparency between the RBI and other
Indian banks. The RBI decides the SLR.

What is the reverse repo rate?

A rise in the reverse repo rate reduces the money supply (assuming all other factors remain
unchanged). Banks are incentivised to deposit more money with the central bank, as they earn
a higher return on these funds.
When the RBI decreases the reverse repo rate, banks earn less on their parked funds, which
encourages them to lend more to consumers and businesses. Increased credit availability in
the market can fuel demand, boost economic growth, and contribute to job creation and
higher consumer spending.
Current reverse repo rate in 2024

The current repo rate in India is 6.50% (as of 14th October 2024), while the reverse repo rate
is at 3.35%. Note that the repo rate and reverse repo rate together help the central bank
manage liquidity and maintain financial stability in the economy.