Context: The Reserve Bank of India (RBI) has exempted banks from maintaining cash reserve ratio (CRR) for loans to retail and micro, small and medium enterprises for five years, if these loans are extended between January 31 and July 31, 2020.

Background:

At present, CRR is 4% of net demand and time liabilities. Banks do not earn any interest for maintaining CRR with the RBI.

What is CRR?

• It is a certain minimum amount of deposit that the commercial banks have to hold as reserves with the central bank.
• The percentage of cash required to be kept in reserves, vis-a-vis a bank’s total deposits, is called the Cash Reserve Ratio.
• The cash reserve is either stored in the bank’s vault or is sent to the RBI. Banks do not get any interest on the money that is with the RBI under the CRR requirements.

Cash reserve ratio is:

1. It is also referred to as the amount of funds which the banks have to keep with the Reserve Bank of India (RBI).
2. It’s a vice-versa process.
3. If a central bank increases CRR then the available amount with the banks decreases or comes down.
4. The CRR is used by RBI to wipe out excessive money from the system.

There are two primary purposes of the Cash Reserve Ratio:

1. Since a part of the bank’s deposits is with the Reserve Bank of India, it ensures the security of the amount. It makes it readily available when customers want their deposits back.
2. Also, CRR helps in keeping inflation under control. At the time of high inflation in the economy, RBI increases the CRR, so that banks need to keep more money in reserves so that they have less money to lend further.

How does Cash Reserve Ratio help in times of high inflation?

At the time of high inflation, the government needs to ensure that excess money is not available in the economy.

• To that extent, RBI increases the Cash Reserve Ratio, and the amount of money that is available with the banks reduces. This curbs excess flow of money in the economy.

When the government needs to pump funds into the system, it lowers the CRR rate, which in turn, helps the banks provide loans to a large number of businesses and industries for investment purposes. Lower CRR also boosts the growth rate of the economy.