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Author Topic: Article - What Is CRR ( Cash Reserve Ratio)  (Read 6384 times)

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Article - What Is CRR ( Cash Reserve Ratio)
« on: February 01, 2008, 12:45 AM »
What is CRR?

Cash Reserve Ratio - Banks need to deposit certain amount to the Federal Reserve ( From your name I think you are in India then it will be Reserve bank of India )from total deposits made by Customers.

For Example if CRR is 10 % then If you deposit 1000$ to the bank then bank has to deposit 100 $ to the Federal Reserve.

It has lots of usage but in simple terms it is done to meet unexpectred outflow of cash.


How is crr calculated?i need the answer in simple terms.?

CRR is a ratio of bank's deposit and liquidity.if a bank has hundred crore deposit and it issues loan of Rs. hundred crore than it will be problematic.in case the investor demand money at once how the bank will pay?.bank cannot demand from it's debtors.so the central bank of any country regulates the banking system in the way that bank earns income and in the same time it has so much liquid funds so that it can pay any emergency demand.in this exercise the central bank also control the money flow of market.


Relaion between crr and inflation?

?   There is no direct cause and effect relationship between CRR and inflation. There is a school of economic thought that if the economy is in or near full employment of resources like productive capacity and labor, prices tend to rise if the money supply increases. Higher money supply means higher the demand for goods and services. This link is provided through the concept of money multiplier. Money supply is measured by various indicators: the most used measurement of money is currency incirculation with the public plus checkable demand deposits on which there is no withdrwal restrictions (In India we call them Current Account) plus a percentage of the savings and fixed deposits because even these deposits can be withdrwan at short notice. Thus, if the deposits increases money supply increases in the first round by the amount of increase in deposits (100% in the case of current deposits a lower percentage in the case of other deposits). But as the deposits increase, the banks try to increase their loans so that they can earn income and increase their profits. However, they cannot increase the loans exactly by the amount of the extra deposits they receive. This is because they have to keep some cash or liquid investments (like in short-tenure Govt securities that can be easily sold in the market to get cash) with them should the depositors need to withdraw cash. The Reserve Bank of India stipulates that no bank should run out of cash when the depositors want to withdraw cash from their deposit accounts. This minimum requirement imposed by the RBI is the Cash Reserve Ratio or CRR that banks have to maintain. CRR is fixed as a percentage of the deposits liabilities of the banks. Let us say that the CRR is 10 %. So, when a bank receives a deposit of Rs 100, it can extend a loan of Rs 94 keeping the balance Rs.10 in cash reserve. But when the bank lends it does not give out cash. It creates a loan account in which it credits the loan amount as deposit of the loanee. So, the bank's deposits increase by another Rs94 immediately. Now the loane does not draw all the amount in cash. The loanee, say a company, makes payment to its suppliers of inputs and salaries to labor in checks. So the bank keeps 10% of Rs 90 in cash reserve and again makes another loan with the rest of the money of Rs 81 and therefore creates another deposit of Rs 81. This process of loan and deposit creation continues, till the sum of all these deposits becomes so big that the original deposits of cash of Rs100 become only 10% of the total deposits created by loans. Thus if the CRR is 10% and the initial deposit is Rs 100,the bank can actually increase the deposits by rs (100/0.06)= Rs1000 , consisting of the initial deposit of Rs 100 and the successive loan based deposits of Rs900 (90 + 81+ ... +.....).
Now when the Reserve Bank thinks that the inflation is rising it wants the money supply or money supply to go down. So, it raises the CRR. let us say the CRR is raised to 20%.. Now the banks ability to create loans and deposits gets reduced. With Rs 100 initial deposit in cash it can noe create total deposits of Rs(100/ 0.20)= Rs 500. So the money supply now can increase by Rs 500 rather than Rs1000. Thus by raising the CRR the RBI is able to curb credit growth, deposit growth and money supply growth. RBI expects with the slower growth in money supply, the credit or advances of the banks will grow at a slower pace and hence the demand for good and services will grow at a slower pace and therefore the inflation rate will come down. It may be noted when the banks can expand loans at a lower rate, they would raise interest rates so that they give loans to borrowers who are capable of paying higher interest rates. This therefore reduces the demand for loans as well. Slower loan growth implies slower expansion of goods and services in the economy. Thus the pressures on price to rise goes down.
This is briefly the long indirect relationship between CRR and inflation.
In this illustration for simplicity we have talked of CRR being raised from 10% to 20%. In actual practice the changes in CRR is normally by one or one-half percentage from say increase from 7 % to 7.5 % or 8%.
Notes:
1.Monetarists assert that the empirical study of monetary history shows that inflation has always been a monetary phenomenon. The Quantity Theory of Money, simply stated, says that the total amount of spending in an economy is primarily determined by the total amount of money in existence. From this theory the following formula is created:
P= Dc/Sc where P is the general price level of consumer goods, Dc is the aggregate demand for consumer goods and Sc is the aggregate supply of consumer goods. The idea is that the general price level of consumer goods will rise only if the aggregate supply of consumer goods falls relative to aggregate demand for consumer goods, or if aggregate demand increases relative to aggregate supply. Based on the idea that total spending is based primarily on the total amount of money in existence, the economists calculate aggregate demand for consumers' goods based on the total quantity of money. Therefore, they posit that as the quantity of money increases, total spending increases and aggregate demand for consumer goods increases too. For this reason, economists who believe in the Quantity Theory of Money also believe that the only cause of rising prices in a growing economy (this means the aggregate supply of consumer goods is increasing) is an increase of the quantity of money in existence, which is a function of monetary policies, generally set by central banks that have a monopoly on the issuance of currency, which is not pegged to a commodity, such as gold. The central bank of the United States is the Federal Reserve; the central bank backing the euro is the European Central Bank. No one denies that inflation is associated with excessive money supply, but opinions differ as to whether excessive money supply is the cause

?   Dear Sister Diksha, CRR i.e. CASH RESERVE RATIO is the percentage of Deposits with the Bank which are to be maintained in the form of cash or reserves with Reserve Bank of India(RBI) . This will ensure sufficient amount at the disposal of the bank to cater to the withdrawals by the depositors on demand. Now comes your question as to the role of CRR in controlling inflation. Always remember that when banks lend money to people, new money is created. The Bank lends this money out of deposits with the bank . Example say A has deposited 50000 in the bank, now bank lends this 50000 to B who needs it to make payment to C for purchasing goods from C. Now 50000 in the hands of C is new money. Now if C deposits this money in his bank, the same process will be repeated again and when C?s bank will lend money to D who needs it make payment to E which E deposits in his bank, new money will be created which will now be in the hands of E. Now just see how much money is created , A?s deposits with his bank, 50000 + C?s deposits with his bank, 50000+ E?s deposits with his bank,50000. It totals upto 150000.
This process by which the initial money of 50000 multiplied into 150000 is called CREDIT EXPANSION. Inflation is excess of the purchasing power over the value of goods and services that could be bought with that money. When CREDIT EXPANSION takes place, the purchasing power in the economy increases like we saw in the example above. Thus when RBI increases the CRR ratio, the capacity of banks to lend money decreases and thus the volume of credit expansion decreases thus the purchasing power is controlled to that extent. This method of controlling inflation adopted by the RBI to control inflation is called a MONETARY MEASURE. Thus whenever banks lend money new money is created. Thus it is the lending capacity of the banks which the CRR aims to control. All the best.


Latest SLR/CRR prescribed by RBI?

CRR is 6.25% and SLR is 25%.


Rise of CRR rate by RBI in INDIA ? In US Do they have same system ? How they control Inflation ?
In india they are rising CRR rate by RBI to control inflation.What about in US ? how they control their inflation & how they have money flow contol ? Is it related with country revenue(EXPORT value should be higher than IMPORT value) or it seems US have controled inflation rate ? their prices are not rised every year(only very minor rise). why is it so difference here & their ?
what makes a country to control inflation & balanced growth ?

Best Answer -
The U.S.'s central bank is the Federal Reserve or Fed as it is commonly called. The Fed has many monetary policy tools to control inflation and aid money flow control. However within the last 10 to 20 years the Fed has only used 1 tool: the Federal Funds Target Rate, currently at 5.25%. The Fed can use reserve ratios (and has in the past) like the RBI to control inflation, promote growth, and aid money flow.

Federal Funds Target Rate is an interest rate that the Fed attempts to maintain (by adding or subtracting money by buying and selling government bonds) as closely as possible in the interbank market for overnight funds to meet the Fed's reserve requirements for commercial banks. These banks have a reserve requirement that must be held at the Fed and if they cannot meet that requirement they can go into the interbank market for federal funds to borrow it for overnight use.

RBI could just try to target a market interest rate like the Fed does (Fed also controls the monetary base but does not really use it so publicly like Federal Funds). I do not think interest rate targeting will work as well, if at all, in India because India's capital markets (stock, bond, and credit markets) are not as developed to adjust the economy effectively as in the US. Recently the RBI has confused markets with its monetary policy moves.

To control inflation and promote growth, the Fed has been more open into its thinking, reasoning, and forecasting in the last 10 years which has probably done more good than just using monetary policy tools like reserve requirements, interest rate targets, monetary base, etc......



Why the RBI is increasing CRR rate,when we all say that our economy is growing @ 9%p.a?

?   Crr rate is hiked due to liquidity crunch. In every growing economy people tend to spend more, be it real estate investments, consumer goods. All these add to the credit offtake due to easy availibility of loans. As a result crunch.The watch dog RBI has taken the right step in doing so, it may help contain the loans offtake.The money is very much there but only borrowing gets expensive.Its time to open our eyes otherwise harsh realities are not far away...Stock market crash followed by real estate crash and so on.
?   The RBI is increasing the crr because the lending to deposit ratio of the banks are decreasing meaning that banks are lending more that they have reserves for it.
By increasing the crr by 50 basic points banks will have money of about Rs 13500 cr which will be available for loan disbursement.Also when the economy is in a buoyant stage it is good to have some capital formation and increase the savings rate.
How raises in CRR help RBI in curbing inflation.?
How raises in CRR help RBI in curbing inflation?Explain the phenomenon with the help of incidence from the past where CRR and inflation correlation was proved.

Best Answer ?
Dear Friend, CRR i.e. CASH RESERVE RATIO is the percentage of Deposits with the Bank which are to be maintained in the form of cash or reserves with Reserve Bank of India(RBI) . This will ensure sufficient amount at the disposal of the bank to cater to the withdrawals by the depositors on demand. Now comes your question as to the role of CRR in controlling inflation. Always remember that when banks lend money to people, new money is created. The Bank lends this money out of deposits with the bank . Example say A has deposited 50000 in the bank, now bank lends this 50000 to B who needs it to make payment to C for purchasing goods from C. Now 50000 in the hands of C is new money. Now if C deposits this money in his bank, the same process will be repeated again and when C?s bank will lend money to D who needs it make payment to E which E deposits in his bank, new money will be created which will now be in the hands of E. Now just see how much money is created , A?s deposits with his bank, 50000 + C?s deposits with his bank, 50000+ E?s deposits with his bank,50000. It totals upto 150000.
This process by which the initial money of 50000 multiplied into 150000 is called CREDIT EXPANSION. Inflation is excess of the purchasing power over the value of goods and services that could be bought with that money. When CREDIT EXPANSION takes place, the purchasing power in the economy increases like we saw in the example above. Thus when RBI increases the CRR ratio, the capacity of banks to lend money decreases and thus the volume of credit expansion decreases thus the purchasing power is controlled to that extent. This method of controlling inflation adopted by the RBI to control inflation is called a MONETARY MEASURE. Thus whenever banks lend money new money is created. Thus it is the lending capacity of the banks which the CRR aims to control. All the best.


What is the difference between Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)?

Best Answer -
?   statutory liquidity ratio say 25 % means to that extent the bank or an NBFC has to hold in government securities in value against demand and time liabilities toward solvency requirements [what if the bank advances the entire 100% of the deposits collected instead of investing partly in govenment securities your risk profile will increase and depositor funds are less safe?]. this is assuming that govt is the lowest credit risk. This is also one window open for funding for the government. CRR ratio enables setting aside 5% to 6% [say in the case of india] to ensure that liquidity is maintained by the bank and normally in cash or equivelents [currency chests are also taken for CRR calc]. when the central bank increases say CRR [as in india recently] lendable resources available to the bank are lower to that extent. the aim is primarily to tackle the inflationary pressures in the economy.

?   SLR is the minimum amount of cash, gold, and other securities that have to be on hand in relation to a bank's total liabilities and is set by statute. CRR is the percentage of bank reserves to deposits and notes. It changes based upon the operations at the bank.

?   Cash reserve ratio only involves cash and cash equivalents. The Federal reserve uses something like this to help regulate monetary policy in the US. The higher the required reserve, the less banks are able to loan out. The less they loan out, the less economic activity there is in the country.(Cash reserves have a multiplier effect in the economy. When a bank loans out $1, it multiplies into many dollars as a result of the next several users down the line. The Federal Reserve can stimulate the economy by lowering the reserve.)Statutry liquidity ratios act as a second safety net. "Statutory" means that the ratio has been enacted as a law or regulation. "Liquidity" refers to the types of assets required in reserve. They will often include cash, cash equivalents, receivables, investments, and other short-term assets that can be made liquid in a short time without a substantial penalty.Cash equivalents are usually anything that can be turned into cash in 90 days or less.Short term assets are usually turned into cash in a year or less.

 
 

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Offline priyabala

Re: Article - What Is CRR ( Cash Reserve Ratio)
« Reply #1 on: August 30, 2011, 09:55 PM »
very good
 

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