MC Explains | What RBI’s CRR cut means for borrowers and the economy

The CRR is the portion of a bank's total deposits that it must keep with the RBI and cannot use for lending or investing.

The Reserve Bank of India on December 6 reduced the Cash Reserve Ratio (CRR), or the percentage of a bank’s total deposits kept in liquid cash with the central bank as a reserve, by 50 basis points to 4 percent. The move is significant for borrowers as it will free up Rs 1.16 lakh crore of liquidity in the system.

The six-member Monetary Policy Committee (MPC), however, decided to keep the policy repo rate unchanged at 6.50 percent following a 4:2 majority vote. Repo is the rate at which commercial banks borrow money from the RBI. As a result, rates for lending and deposits for banks are likely to remain stable for now.

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What Does the CRR Cut Mean?

The reduction in CRR will inject Rs 1.16 lakh crore into the banking system. This money can be used by banks for lending, investment, or other purposes. RBI Governor Shaktikanta Das stressed that the financial sector is in its healthiest position in years, thanks to this move.

This change is important because it frees up cash for banks to lend more to borrowers, such as businesses and individuals. This can also help boost investment and economic growth, especially at a time when the economic growth has slowed down.

How Does the CRR Work?

The Cash Reserve Ratio is essentially the percentage of a bank’s total deposits that it must keep with the RBI as a reserve. For example, if the CRR is 4 percent and a bank has Rs 1,00,000 in deposits, it must set aside Rs 4,000 with the RBI. The bank cannot use this money for lending or investments, and it does not earn interest on this deposit.

The banks need to maintain this reserve to ensure they can meet customer withdrawal demands. If the banks do not keep enough reserves, it could lead to liquidity crisis.

Also Read | RBI keeps repo rate unchanged, stance remains 'neutral'

Why Does the RBI Change the CRR?

The RBI adjusts the CRR to manage inflation and liquidity in the economy. When inflation is high, the RBI increases the CRR to reduce the amount of money banks can lend, helping to control inflation. On the other hand, when the economy is slowing down, the RBI lowers the CRR to increase the amount of money available for lending, which can stimulate growth and investment.

By cutting the CRR now, the RBI is aiming to boost economic activity, particularly at a time when growth is slower than expected.