Market Live brings in the Stock Market Tutorial which explains the basics of Economics. You will get to know all the information that you ever wanted to know on the CRR, the reverse repo rates and other interest rates fixed by the Central Bank (RBI), and what they mean to you.
It is the rate at which the RBI borrows money from other banks. Commercial banks would deposit their money with the RBI and earn an interest rate equal to the Reverse repo rate.
An increase in the reverse repo rate will make it attractive for the banks to keep their money with the RBI, earning higher interests on idle cash. Thus it is used as a tool to by the RBI to drain the excess money in the banking system.
CRR stands for the Cash Reserve Ratio. Every commercial bank that operates, has to keep a certain percentage of funds in the form of cash. Banks have to deposit this minimum amount of funds in the form of cash with the RBI or the currency chests.
This minimum ratio that the banks have to hold as cash with RBI, is called as the Cash Reserve Ratio or the CRR.
For example, if a bank manages a deposit of Rs. 1 lakh, and if the CRR is stipulated as 4%, it means that the bank has to deposit a sum of Rs.4000/- as cash reserve with the RBI. It essentially leaves only Rs.96,000/- to the bank which can be used for investing, lending or credit purposes.
CRR is used as a tool by the RBI to control the liquidity in the banking system. RBI chooses to alter the CRR to cause a decrease or an increase in the money supply in the system.
When the RBI increases the CRR, the banks are mandated to deposit a larger amount of their deposits with the RBI. This will cause a reduction in the amount available for the banks to lend it to their subscribers. It will in turn result in a decrease in the money supply, with a reduction in the liquidity.
On the contrary, when the RBI decreases the CRR, banks are allowed with a higher proportion of money, which can be used for investments and lending. This will in turn result in an increase in the money supply with an increased liquidity in the system.