CRR stands for Cash Reserve Ratio. The CRR is a measure of a bank’s liquidity. It is the percentage of its total deposits that the bank sets aside in cash or as cash equivalent.
Cash Reserve Ratio is calculated by dividing a bank’s cash and near cash holding by its total deposits.
CRR =(Cash or Cash Equivalent/Total Deposits)*100%
The CRR is the measure of how much money a bank has available to lend out as opposed to how much it owes. The higher the ratio, the more liquid a bank is and vice versa.
With respect to loan lending, a lower cash reserve ratio means that the bank has more money available to lend out, which increases the likelihood of loans being granted. A higher cash reserve ratio means that the bank has less money available for lending, which decreases the likelihood of loans being granted.
This ratio is an important aspect of the monetary policy that a central bank uses. It is also an important tool for managing liquidity in the banking system. The cash reserve ratio is one of many tools that a central bank has at its disposal when implementing monetary policy. The primary objective of this tool is to control liquidity in the banking system and by extension, inflation rates.
This ratio in particular provides insight into just how liquid a bank is and whether it can support customer requests for withdrawals during a severe economic downturn or the early stages of recovery.
Significance of the Cash Reserve Ratio in Financial Institutions
CRR has many important implications for financial institutions. First, it affects their liquidity and ability to meet withdrawal requests from customers. Second, it determines how much interest they pay on deposits and charge on loans. Third, it impacts the likelihood that they will fail due to insolvency or insolvency risk. And finally, it dictates how much they can lend out without risking defaulting on loans or paying penalties for excess reserves held above regulatory requirements .The key to successful banking is proper liquidity management. This ratio in particular provides insight into just how liquid a bank is and whether it can support customer requests for withdrawals during a severe economic downturn or the early stages of recovery.
Types of Cash Reserve Ratio
There are two types of Cash Reserve Ratio (CRR) :
- Statutory CRR
- Prudential CRR
The Statutory Cash Reserve Ratio (SCRR) is the amount of money that banks are required to keep in cash or with the Central Bank. It is also known as Liquidity Coverage Ratio (LCR). The higher the percentage, the more money that is available for lending.
The Prudential Cash Reserve Ratio(PCRR) is the amount of money a bank must keep in reserve for every amount it lends out. The higher the PCRR, the more conservatively a bank behaves.
There are two main reasons why banks have to keep cash in their vaults:
- To meet their obligations to depositors
- To ensure that they can continue to function as a financial intermediary in case they need to call back loans or issue new loans.
Benefits of Cash Reserve Ratio
- CRR ensures that total liquidity is evened out through circulation throughout the economy.
- The CRR ratio is set by the amount of money available in the financial market. When there’s more cash on hand, this means less demand for loans, and the central bank will raise their CRR accordingly to avoid over-indebting. Likewise, in the event of a liquidity crisis or a reduction in the economy’s monetary supply, the central bank will lower the CRR rate to allow more money to flow into the market
- CRR can help commercial banks maintain their solvency.
- CRR ensures liquidity within the financial system is coherent and successfully maintained.
- The CRR is an important metric because it helps control banks’ credit supply. This keeps cash and credit flowing within the economy.
- The CRR is a more effective tool than other instruments to control money supply.