The Cash Reserve Ratio refers to a certain percentage of total deposits the commercial banks are required to maintain in the form of cash reserve with the central bank.
The objective of maintaining the cash reserve is to prevent the shortage of funds in meeting the demand by the depositor. The amount of reserve to be maintained depends on the bank’s experience regarding the cash demand by the depositors. If there had been no government rules, the commercial banks would keep a very low percentage of their deposits in the form of reserves.
Since cash reserve is non-interest bearing, i.e. no interest is paid on the deposits, therefore, the commercial banks often keep the reserve below the safe limits. This might lead to a financial crisis in the banking sector. Thus, in order to avoid such uncertainty the central bank imposes a cash reserve ratio or CRR on commercial banks. The central bank has the legal power to change the CRR any time at its discretion. The cash reserve ratio is a legal requirement and therefore it is also called as a
Statutory Reserve Ratio (SRR ).
Through a cash reserve ratio, the central bank can change money supply in the economy. Such as, when the economy demands a Contractionary Monetary Policy the central bank will raise the CRR . On the other hand, when the economic conditions, demand for an Expansionary Monetary Policy the central bank
cuts down the CRR .