Cash Reserve Ratio (CRR) Cash reserve ratio, or CRR, is the proportion of deposits that banks have to hold in the form of cash with the Reserve Bank of India. Banks are mandated to deposit this amount with RBI on a fortnightly basis.
For e.g: if the CRR is 5%., this means for every Rs100 deposited in the bank, it needs to deposit Rs 5 with RBI. The bank is then only allowed to only spend Rs95 (Rs 100 - Rs 5) for investment and lending purposes.
Significance of CRR CRR is a tool used by the RBI to control the liquidity in the system. So when there is excess money floating around, RBI will increase the CRR to suck out the excess. On the other hand, if the economy is facing a credit crunch, the RBI then decreases the CRR to release money into the system.
For the common man, any adjustment in the CRR might have an impact on lending rates. When CRR increases, banks have lesser amount to lend and hence the cost of money goes up. This is sometimes reflected in higher interest rates that borrowers have to pay on their loans.
Repo Rate Repo or Repurchase rate is the rate at which the RBI lends short-term money to banks (money market). When the repo rate increases, borrowing from RBI becomes that much more expensive. When repo rate goes down, banks can borrow at a cheaper rate from the RBI.
Significance of Repo Rate RBI uses this tool when it wants to control the amount of money that gets injected into the system. In case of a credit crunch, RBI considers decreasing the repo rate so that banks can borrow at cheaper rates from the RBI.
Reverse Repo Rate Reverse Repo rate is the rate at which RBI borrows money from the banks. When RBI increases the reverse repo rate, banks get that much more interest on the money lent to the RBI.
Significance of Reverse Repo Rate The RBI uses this tool when it feels there is too much liquidity in the banking system. An increase in the reverse repo rate means that the RBI will borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep their money with the RBI
The RBI uses a combination of these tools to control the amount of money floating in the system. For e.g: During the slowdown of 2008, the RBI reduced the CRR from 8% to 5.5% in a span of just 6 months. This was done to encourage borrowing amongst corporates and households, which the government hoped would kick-start investment activity across the economy.