Every commercial/Scheduled bank in India has to keep certain minimum amount of cash reserves with Reserve Bank of India (RBI). Reserve Bank of India uses CRR as a tool to increase or decrease the reserve requirement depending on whether RBI wants to increase or decrease in the money supply. RBI can vary Cash Reserve Ratio (CRR) rate between 3% and 15%. An increase in CRR will make it mandatory for the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the amount of Bank deposits and they will lend less as they have less amount as their reserve. This will in turn decrease the money supply. If RBI wants to increase Money supply it may reduce the rate of CRR and it will allow the banks to keep large amount of their deposit with themselves and they will lend more money. It will increase the money supply. For example: When someone deposits Rs.100 in a bank, it increase the deposit of banks by Rs100, and if the cash reserve ratio is 9%, the banks will have to hold additional Rs 9 with RBI and Bank will be able to use only Rs 91 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 for lending and investment. RBI uses CRR to control liquidity in the banking system.
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, 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].
Present Cash Reserve Ratio (CRR) is 4%