Quick Learning Cash Reserve Ratio

The present banking system is called a fractional reserve banking system, as the banks are required to keep only a fraction of their deposit liabilities in the form of liquid cash with the central bank for ensuring safety and liquidity of deposits. The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the Reserve Bank of India (RBI) as a certain percentage of their demand and time liabilities. For example if the CRR is 10% then a bank with net demand and time deposits of Rs 1,00,000 will have to deposit Rs 10,000 with the RBI as liquid cash. How is CRR used as a tool of credit control? CRR was introduced in 1950 primarily as a measure to ensure safety and liquidity of bank deposits, however over the years it has become an important and effective tool for directly regulating the lending capacity of banks and controlling the money supply in the economy. When the RBI feels that the money supply is increasing and causing an upward pressure on inflation, the RBI has the option of increasing the CRR thereby reducing the deposits available with banks to make loans and hence reducing the money supply and inflation. Does RBI impose on penalty on banks for defaulting on CRR deposits? The RBI has the authority to impose penal interest rates on the banks in respect of their shortfalls in the prescribed CRR. According to Master Circular on maintenance of statutory reserves updated up to June 2008, in case of default in maintenance of CRR requirement on daily basis, which is presently 70 per cent of the total CRR requirement, penal interest will be recovered at the rate of three 3% per annum above the bank rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day. If shortfall continues on the next succeeding days, penal interest will be recovered at a rate of 5% per annum above the bank rate. In fact if the default continues on a regular then RBI can even cancel the banks licence or force it to merge with a larger bank. Does CRR apply to all scheduled banks? The CRR is applicable to all scheduled banks including the scheduled cooperative banks and the Regional Rural Banks (RRBs). The present level of CRR is 6.5%. Previously, there was a floor of 3% and ceiling of 20% on the CRR that could be imposed by the RBI; however since 2006 there is no minimum or maximum level of CRR that needs to be fixed by the central bank of India. At present, the RBI does not pay any interest to the banks on the CRR deposits. Prior to 1962, a separate CRR was fixed in respect of demand and time liabilities, however after 1962 the separate CRRs were merged and one CRR came into effect for both demand and time deposits of banks with RBI.

What Is Cash Reserve Ratio And How Will The CRR Hike Impact You?

Cash Reserve Ratio is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault (vault cash), or with a central bank. The reserve ratio is sometimes used as a tool in monetary policy, influencing the countrys economy, borrowing, and interest rates. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they prefer to use open market operations to implement their monetary policy. The Peoples Bank of China does use changes in reserve requirements as an inflation-fighting tool, and raised the reserve requirement nine times in 2007. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits (component of money supply M1 ), and zero on time deposits and all other deposits. An institution that holds reserves in excess of the required amount is said to hold excess reserves. Cash reserve Ratio (CRR) in India is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks. From a stock market perspective Rising interest rates have several implications including * Results in slow down in the overall growth in the economy; this effectively means that adverse impact of demand for goods and services, and investment activity. * apart from the fact that overall growth is impacted, companies take a hit on account of higher interest costs that they have to bear on their outstanding loans (to the extent their cost of funds is not locked in) * since some investors tend to leverage and invest in the stock markets, higher interest rates increase expectation of returns from the stock markets; this has the impact of lowering current stock prices * an overall decline in stock prices has a cascading effect as leveraged positions are unwound (on account of meeting margin requirements), leading to still lower stock prices So, from a short term perspective, higher interest rates should adversely impact stock market sentiment. From a long term perspective however our expectations of returns from the stock markets remains unchanged. As mentioned earlier, RBIs move to tame inflation over the long term augurs well for long term economic growth (there is more predictability and therefore risk premiums are lower). This will ultimately benefit well-managed companies. So what should you do now?

Its difficult to say how the stock markets will react; or for that matter to what extent the markets will react. In the last few trading sessions, there has already been a correction of about 4 per centSE Sensex. Any irrational fall in stock prices, in our view, should be seen as an opportunity to add to your exposure, in installments, to equities/equity funds, your planned asset allocation permitting. Your Personalfn consultant will be able to guide you in this regard. It is impossible to predict near term movement in stock prices. And therefore any investment you consider should be made keeping in mind that in the near term you could be sitting on losses on fresh investments. From a 5 year perspective however we are reasonably confident that a well managed equity fund can deliver returns in the range of 12-15 per cent per year. This is not to say that you will make this return every year. There will be years in which you may lose money, and others where you may make far more than what we have projected. Over the 5 year tenure, on a point to point basis, you will average a return of 12-15 per cent per annum, which in our view is a realistic estimate. From a debt market perspective If you are contemplating on investing monies in the debt market, you will benefit from higher interest rates on offer. However, existing investors in debt oriented funds may take a one time hit; but at the same time, since overall interest rates are higher, from here on, such funds will yield higher returns. So what should you do now? Although the interest rates have risen quite a bit, it may still not be the best time to lock in all your money in long term debt instruments (interest rates may still rise). Go in for short term Fixed Maturity Plans, which yield attractive post tax returns (you could get an annualised return of about 8 per cent on a post tax basis for a three month deposit). If you can take some risk, go in for well managed Monthly Income Plans (MIPs) that are offered by mutual funds. Go in for the low risk option (equity less than 20 per cent of assets) with a quarterly dividend option. With higher interest rates and possibly lower stock prices, MIPs could yield an attractive post tax return. From the perspective of a borrower As a prospective borrower, you are the worst hit. The cost of money i.e. interest rates will rise post the CRR hike. You will probably need to settle in for a lower loan amount given the EMI. If you are an existing borrower, as long as the rate of interest on your loan is fixed, you are

immune to any rise in interest rates. However, if you have a floating rate loan, then expect either the tenure of the loan or the EMI to jump soon.

The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank. The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's borrowing and interest rates by changing the amount of loans available[1]. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling governmentissuedbonds) to implement their monetary policy. The People's Bank of China uses changes in reserve requirements as an inflation-fighting tool,[2]and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits. An institution that holds reserves in excess of the required amount is said to hold excess reserves.

he reserve requirement can affect monetary policy, because the higher the reserve requirement is set, the less money banks will have to loan out, leading to lower money creation, and maintaining the purchasing power of the currency previously in use. The effect is exponential, because money that is loaned out can be re-deposited; a portion of that money may again be re-loaned, and so on. The effect on the monetary supply is governed by the following formula:

MS = Money Supply Mb = Monetary base mm = money multiplier c = rate at which people hold cash (as opposed to depositing it), equal to one minus marginal
propensity to consume

R = the reserve requirement (the percent of deposits that banks are not allowed to lend)
However, in the United States (and other countries except Brazil, China, India, Russia), the reserve requirements are generally not frequently

altered to affect monetary policy because of the exponential effect and the large time lag between the implementation of the change and the corresponding effects on inflation.[citation needed]