Cash reserve ratio (CRR) is generally defined as a particular minimum amount of deposits that needs to be maintained as a reserve by every commercial bank. All deposits cannot be used for credit creation. Banks must keep a certain percentage of deposits in cash reserve. The volume of bank credit depends also on the cash reserve ratio the banks have to keep. If the cash reserve ratio is increased, the volume of credit that the banks can create will fall. If the cash reserve ratio is lowered, the bank credits will increase. The aim is to ensure that banks do not run out of cash to meet the payment demands of their depositors.
Objective existence of cash reserve ratio:
- The objective of maintaining the cash reserve is to prevent the shortage of funds in meeting the demand by the depositor.
- Cash reserve ratio ensures that a part of the bank’s deposit is with the Central Bank and is hence, safe
- The second and a very important reason are for the purpose of combating inflation.
It is a particular minimum portion of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. The central bank has the power to prescribe and change the cash reserve ratio to be kept by the commercial banks. Thus the central bank can change the volume of credit by changing the cash reserve ratio.