How increase or decrease in CRR (Cash Reserve Ratio) affects the money flow in Market?
Hike in CRR drains out excess liquidity from the banking system and vice versa. Presently excess liquidity is just under Rs 1 trillion. The move by RBI to hike CRR by 75 bps yesterday will drain liquidity to the tune of Rs 360 billion. Banks used to park excess funds with the central bank and earn reverse repo rate. However, funds parked under CRR dont earn any interest and thus banks will loose out on that. Hike in CRR will thus affect the NIM’s of banks to the tune of 5 bps approx.
This was selected as Best Answer Cash Reserve Ratio is that portion of banks total deposits which Banks have to park with Central Bank (RBI in India). A bank earns its income through lending at higher rates and paying low rate of interest on Deposits. So any increase in CRR leads to lesser amount of money at disposal of banks, which can be given as advances and loans, thereby sucking liquidity in market. On the other hand, a decrease in CRR implies more money at disposal of banks, and hence more liquidity in market. Increase in CRR means lesser liquidity, which in turn leads, to higher interest rates, implying fewer new projects, more interest costs for companies and individuals on their outstanding portion of loans (if taken on variable or market linked rate of interest), less spending on luxuries, lesser investments opportunities, etc. this will cause lesser demand and hence prices will come down (i.e. inflation rate will come down).
