Cash Reserve Ratio====

The present banking system is called a fractional reserve banking system, as the banks are required to keep only a fraction of their deposit liabilities in the form of liquid cash with the central bank for ensuring safety and liquidity of deposits. The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the Reserve Bank of India (RBI) as a certain percentage of their demand and time liabilities. For example if the CRR is 10% then a bank with net demand and time deposits of Rs 1,00,000 will have to deposit Rs 10,000 with the RBI as liquid cash.

How is CRR used as a tool of credit control?

CRR was introduced in 1950 primarily as a measure to ensure safety and liquidity of bank deposits, however over the years it has become an important and effective tool for directly regulating the lending capacity of banks and controlling the money supply in the economy. When the RBI feels that the money supply is increasing and causing an upward pressure on inflation, the RBI has the option of increasing the CRR thereby reducing the deposits available with banks to make loans and hence reducing the money supply and inflation.

Does RBI impose on penalty on banks for defaulting on CRR deposits?

The RBI has the authority to impose penal interest rates on the banks in respect of their shortfalls in the prescribed CRR. According to Master Circular on maintenance of statutory reserves updated up to June 2008, in case of default in maintenance of CRR requirement on daily basis, which is presently 70 per cent of the total CRR requirement, penal interest will be recovered at the rate of three 3% per annum above the bank rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day. If shortfall continues on the next succeeding days, penal interest will be recovered at a rate of 5% per annum above the bank rate. In fact if the default continues on a regular then RBI can even cancel the banks licence or force it to merge with a larger bank.

Does CRR apply to all scheduled banks?

The CRR is applicable to all scheduled banks including the scheduled cooperative banks and the Regional Rural Banks (RRBs). The present level of CRR is 6.5%. Previously, there was a floor of 3% and ceiling of 20% on the CRR that could be imposed by the RBI; however since 2006 there is no minimum or maximum level of CRR that needs to be fixed by the central bank of India. At present, the RBI does not pay any interest to the banks on the CRR deposits. Prior to 1962, a separate CRR was fixed in respect of demand and time liabilities, however after 1962 the separate CRRs were merged and one CRR came into effect for both demand and time deposits of banks with RBI.

What is CRR Ratio or What is CRR Rate :

The Reserve Bank of India (Amendment) Bill, 2006 has been enacted and has come into force with its gazette notification. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate ( [Before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR for scheduled banks between 3 per cent and 20 per cent of total of their demand and time liabilities]. RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.(a) ensures that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks inlending money.

What is CRR (For Non Bankers) :

CRR means Cash Reserve Ratio. Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks dont hold these as cash with themselves, but deposit such case with Reserve Bank of India (RBI) / currency chests, which is considered as equivlanet to holding cash with RBI. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio. Thus, When a banks deposits increase by Rs100, and if the cash reserve ratio is 6%, the banks will have to hold additional Rs 6 with RBI and Bank will be able to use only Rs 94 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use forlending and investment. This power of RBI to reduce the lendable amount by increasing the CRR, makes it an instrument in the hands of a central bank through which it can control the amount that banks lend. Thus, it is a tool used by RBI to control liquidity in the banking system. Some non bankers also wrongly use CRR Ratio or CRR Rate instead of Cash Reserve Ratio ).

The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customerdeposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank. The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's borrowing and interest rates by changing the amount of loans available[1]. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations(buying and selling government-issued bonds) to implement their monetary policy. The People's Bank of China uses changes in reserve requirements as an inflation-fighting tool,[2] and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits. An institution that holds reserves in excess of the required amount is said to hold excess reserves.

What Is Cash Reserve Ratio And How Will The CRR Hike Impact You?
Cash Reserve Ratio is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault (vault cash), or with a central bank. The reserve ratio is sometimes used as a tool in monetary policy, influencing the countrys economy, borrowing, and interest rates. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they prefer to use open market operations to implement their monetary policy. The Peoples Bank of China does use changes in reserve requirements as an inflation-fighting tool, and raised the reserve requirement nine times in 2007. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits (component of money supply M1), and zero on time deposits and all other deposits. An institution that holds reserves in excess of the required amount is said to hold excess reserves. Cash reserve Ratio (CRR) in India is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.

From a stock market perspective

Rising interest rates have several implications including * Results in slow down in the overall growth in the economy; this effectively means that adverse impact of demand for goods and services, and investment activity. * apart from the fact that overall growth is impacted, companies take a hit on account of higher interest costs that they have to bear on their outstanding loans (to the extent their cost of funds is not locked in) * since some investors tend to leverage and invest in the stock markets, higher interest rates increase expectation of returns from the stock markets; this has the impact of lowering current stock prices * an overall

decline in stock prices has a cascading effect as leveraged positions are unwound (on account of meeting margin requirements), leading to still lower stock prices So, from a short term perspective, higher interest rates should adversely impact stock market sentiment. From a long term perspective however our expectations of returns from the stock markets remains unchanged. As mentioned earlier, RBIs move to tame inflation over the long term augurs well for long term economic growth (there is more predictability and therefore risk premiums are lower). This will ultimately benefit well-managed companies.

So what should you do now?

Its difficult to say how the stock markets will react; or for that matter to what extent the markets will react. In the last few trading sessions, there has already been a correction of about 4 per centSE Sensex. Any irrational fall in stock prices, in our view, should be seen as an opportunity to add to your exposure, in installments, to equities/equity funds, your planned asset allocation permitting. Your Personalfn consultant will be able to guide you in this regard. It is impossible to predict near term movement in stock prices. And therefore any investment you consider should be made keeping in mind that in the near term you could be sitting on losses on fresh investments. From a 5 year perspective however we are reasonably confident that a well managed equity fund can deliver returns in the range of 12-15 per cent per year. This is not to say that you will make this return every year. There will be years in which you may lose money, and others where you may make far more than what we have projected. Over the 5 year tenure, on a point to point basis, you will average a return of 12-15 per cent per annum, which in our view is a realistic estimate.

From a debt market perspective

If you are contemplating on investing monies in the debt market, you will benefit from higher interest rates on offer. However, existing investors in debt oriented funds may take a one time hit; but at the same time, since overall interest rates are higher, from here on, such funds will yield higher returns. So what should you do now? Although the interest rates have risen quite a bit, it may still not be the best time to lock in all your money in long term debt instruments (interest rates may still rise). Go in for short term Fixed Maturity Plans, which yield attractive post tax returns (you could get an annualised return of about 8 per cent on a post tax basis for a three month deposit). If you can take some risk, go in for well managed Monthly Income Plans (MIPs) that are offered by mutual funds. Go in for the low risk option (equity less than 20 per cent of assets) with a quarterly dividend option. With higher interest rates and possibly lower stock prices, MIPs could yield an attractive post tax return.

From the perspective of a borrower

As a prospective borrower, you are the worst hit. The cost of money i.e. interest rates will rise post the CRR hike. You will probably need to settle in for a lower loan amount given the EMI. If you are an existing borrower, as long as the rate of interest on your loan is fixed, you are immune to any rise in interest rates. However, if you have a floating rate loan, then expect either the tenure of the loan or the EMI to jump soon.

What is CRR (Cash Reserve Ratio) ? CRR is Cash Reserve Ratio. It refers to keeping a portion of net demand and time liabilities (NDTL) of banks with the central banks (In India its Reserve Bank of India, RBI). Central bank fixes this percentage of NDTL. Central bank can change this percentage as a monetary measure to control the availability of funds in the economy i.e. to inject liquidity or to suck liquidity. RBI doesnt pay any interest on such funds held with it. The following are the demand liabilities of banks. Banks should pay these liabilities on demand which may come at any time. All liabilities which are payable on demand; they include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, Demand Drafts (DDs),unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Time Liabilities are those which are payable otherwise than on demand; they include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, deposits held as securities for advances which are not payable on demand and Gold Deposits. When a central bank increases CRR, the banks need to reduce the outflow of money by reducing the loans to customers and keep additional amount with the central bank. This usually sucks liquidity in the markets. Lets examine one by one Stock Market: Some traders take leveraged positions (usually 4 5 times their funds) in stock markets by taking additional funds from their brokers at an interest rate. This interest rate goes up as the funds wont be available easily. When the interest rate goes up they reduce the amount of leverage or they take the same leverage positions but expect more returns from Stock market which is possible only when the prices go down. So the overall effect is prices will go down. Bond Market: The banks need to increase interest rates to attract more deposits. The prices of the existing bonds will go down because bonds of same profile will be available with higher interest rates. Over all Economy: Companies find it difficult to raise funds by issuing debentures/bonds because they need to pay more interest. This may cause them to delay the implementation of their expansion plans and the economy slows down. The above said effects are in general. They may or may not happen at same time and the extent of impact will also depend on the rate of increase in CRR. Central banks increase CRR only if it feels there is a lot of liquidity in the market and purchasing power of people is more than required (as expected by the central bank) i.e. when the conditions are hyperinflationary. It reduces the CRR when it feels there is credit crunch in the market and liquidity is very low. The effects will be opposite to the discussed above. This measure is to increase the over all growth rate of the economy. On October 6th RBI reduced CRR by 0.5% and again on 10th October by 1% to ease the credit crunch in the current market conditions and to make funds available to the banks. You can find the latest rates from the RBI website itself. Here I am giving the link. Mouse over on reserve ratios (on Right hand side) to see SLR and CRR.