What is Cash Reserve Ratio?

The commercial banks are required to keep a certain amount of their deposits with the central bank and the percentage of deposits that the banks are required to keep as reserves is called Cash Reserve Ratio.

The banks have to keep the amount to maintain the Cash Reserve Ratio with the RBI.

CRR means that commercial banks cannot lend money in the market or make investments or earn any interest on the amount below what is required to be kept in CRR.

RBI mandates Cash Reserve Ratio so that a percentage of the bank’s deposit is kept safe with the RBI, hence, in an uncertain event bank can still fulfill its obligation against its customers.

CRR also helps RBI to control liquidity in the economy. When CRR is kept at a higher rate, the lower the liquidity in the economy, and similarly when CRR is kept at a lower rate, there is higher liquidity in the economy.

The Reserve Bank of India also regulates inflation through the Cash Reserve Ratio:

• During inflation, that is when RBI wants to apply contractionary monetary policy, it increases CRR so that the money left with banks to lend is reduced. Such measures reduce the money supply in the economy and therefore help combat inflation.
• During deflation, that is when RBI wants to apply expansionary monetary policy, it reduces CRR, so that the money left with banks to lend is increased. Such measures increase the money supply in the economy and therefore help combat deflation.

The formula for CRR is- 

Reserves maintained with Central Banks / Bank Deposits * 100%

For example:

The current CRR is 3% which means that for every Rs 100 deposit in the commercial banks have to keep Rs 3 as a deposit with RBI.