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What is Cash Reserve Ratio (CRR)?

Week of Oct 26 Welcome to the Investors Trading Academy talking glossary of financial terms and events. Our word of the day is “Cash reserve Ratio (CRR)” Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The central bank uses the CRR to drain out excessive money from the system. For example, if the reserve ratio in the U.S. is determined by the Fed to be 11%, this means all banks must have 11% of their depositors' money on reserve in the bank. So, if a bank has deposits of $1 billion, it is required to have $110 million on reserve. CRR limits the ability of the banks to pump more money into the economy. The cash is normally stored in a vault at the bank or with a central bank and cannot be invested or loaned out to businesses or individuals. The requirement is set by each country's central bank and raising or lowering the reserve requirement will subsequently influence the money supply in the economy. If the reserve requirement is raised, banks will have less money to loan out and this effectively reduces the amount of capital in the economy, therefore lowering the money supply. It will mean less money for investment and spending, and would stunt the growth of the economy. It would also mean that banks earn less interest and could see their share prices fall. Lowering the reserve requirement will have the opposite effect; banks will be able to lend more which would increase money supply and stimulate economic growth. By Barry Norman, Investors Trading Academy