What is CRR, repo and reverse repo rate?

What is CRR?
 
Cash Reserve Ratio (CRR) is the amount of funds that banks have to maintain with the Reserve Bank of India (RBI) at all times. If the central bank decides to increase the CRR, the amount available with the banks for disbursal comes down. The RBI uses the CRR to drain out excessive money from the system. Commercial banks are required to maintain an average cash balance with the RBI, the amount of which shall not be less than 3% of the total of Net Demand and Time Liabilities (NDTL) on a fortnightly basis. The RBI is empowered to increase the CRR to ≤20% of the NDTL.

Objectives of CRR

The objective of the CRR is to ensure that the banks maintain a minimum level of liquidity against their liabilities so that they don’t run short of liquidity in case of excess demand for funds. Banks are seen as symbols of trust and any liquidity crisis can lead to a crisis of trust. That is the sole objective of CRR. It is also used by the RBI to give signals on the direction of liquidity, although the RBI does not use it very frequently these days.

How is CRR calculated?

The most important part in the calculation of CRR is the calculation of Demand and Time Liabilities (DTL). The DTL is the total volume of liabilities on which the bank needs to maintain CRR with the RBI. DTL includes demand liabilities like current account deposits, savings account deposits, margins held against L/Cs & guarantees, outstanding TT/MT/DD and call money borrowings. Time liabilities include fixed deposits, cash certificates, recurring deposits etc. However, DTL will exclude loans from RBI, refinance from NHB/NABARD, income tax provisions, unrealized gains/losses from derivative transactions etc. CRR has to be maintained at 4% of this DTL.

Why is CRR kept with RBI?

Banks are required to maintain CRR not only as percentage of the historical deposits but also a percentage of their incremental deposits and these have to be maintained with the RBI on a daily basis. The current rate of CRR is 4% and it is regularly tweaked by the RBI in case it needs to adjust the liquidity in the banking system. Failure to maintain the minimum CRR will lead to imposition of penalties on banks.

Why is cash reserve ratio changed regularly?

CRR balances do not earn any interest as they are kept as a reserve with the RBI in the event of an emergency. The RBI increases the CRR when it wants to suck out liquidity from the banking system and reduce lending capacity. Cutting CRR is part of the RBI's easy money policy and it cuts CRR when it wants to increase the liquidity in the banking system and boost credit. A cut in CRR is also profitable for banks because they can now convert their idle non-income bearing deposits into income-earning assets.

Cash Reserve Ratio is prescribed from time to time and is part of the statutory reserves stipulated by the RBI. Statutory reserves include the CRR and the Statutory liquidity ratio (SLR). The CRR is maintained with the RBI to ensure that banks have sufficient liquidity in order to handle any rush of bank withdrawals and is more of a safety measure.

The RBI increases the CRR when it wants to suck out liquidity from the banking system and reduce lending capacity. Cutting CRR is part of the RBI's easy money policy and it cuts CRR when it wants to increase the liquidity in the banking system and boost credit. A cut in CRR is also profitable for banks because they can now convert their idle non-income bearing deposits into income-earning assets.

What is repo rate?
 
The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy. Whenever banks face a shortage of funds, they can borrow from the RBI as per the repo rate. 
 
A reduction in repo rates helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US. 
 
What is reverse repo rate?

Reverse repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money is in safe hands and earns good interest.
 
An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system.