Cash Reserve Ratio determines the amount that the banks should hold in cash, before deciding on their volume of credit. The level of Cash Reserve Ratio is fixed by the Central Bank of the country. The Central Banks can control the money supply of the country by changing the level of Cash Reserve Ratio.
Cash Reserve Ratio refers to that part of the Depositor’s Balance that the commercial banks should necessarily hold in their hands in form of cash. The commercial banks can decide on the total volume of credit to be provided to the customers, only after maintaining the required level of Cash Reserve Ratio.
In abbreviated form, this Cash Reserve Ratio is referred asCRR.The Cash Reserve Ratio, which is expressed as a percent, varies from time to time. The required level of Cash Reserve Ratio is generally determined by the Central Bank of the Country. For example, in USA, the Federal Reserve of US determines the Cash Reserve Ratio.
In India, Reserve Bank of India fixes the required level of Cash Reserve Ratio.If the Federal Reserve fixes the level of Cash Reserve Ratio at 11%, then it means that, all the banks of USA have to keep 11% of their Depositor’s Money with them in the form of cash.
This in a way ensures the solvency of banks. All the banks use their Depositor’s money in providing credit and they try to expand the volume of bank credit as much as possible in order to generate higher profit. In such a situation, the Cash Reserve Ratio compels the banks to keep a particular part of the Depositor’s Money with them so that, they can pay the customers on their anytime demand.
As the Cash Reserve Ratio controls the banks’ volume of credit, it can be easily understood that, the level of Cash Reserve Ratio affects the money supply of any country. For this reason, Central Bank of any country can control the money supply in the economy by changing the level of Cash Reserve Ratio.
For example, it can be mentioned that the Reserve Bank, the Central Bank of India, often change the level of Cash Reserve Ratio, in order to increase or decrease the money supply of the country.
Last Updated on : 30th July 2013