Cash Reserve Ratio (CRR): This is the minimum amount of funds that a commercial bank must hold with the Reserve Bank of India in the form of deposits. Suppose the total assets of a bank are worth Rs 200 crore and the reserve requirement ratio is 10%. Then the amount that the commercial bank must hold with the RBI is Rs 20 crore. If this ratio rises to 20%, the reserve increases to Rs 40 crore with RBI. Thus, less money remains in the commercial bank for loans. This will ultimately lead to a significant reduction in the money supply. On the contrary, a decrease in the CRR will lead to an increase in the money supply. The Federal Reserve uses the reserve ratio as one of its most important monetary policy tools. The Fed may choose to lower the reserve ratio to increase the money supply in the economy. A reduction in reserve requirements gives banks more money to lend at lower interest rates, making borrowing more attractive to customers. The last time the Fed updated its reserve requirements for various deposit-taking institutions before the pandemic was in January 2019, when banks with more than $124.2 million in net transaction accounts were required to hold a 10% reserve of net transaction accounts.
Banks with more than $16.3 million to $124.2 million had to set aside 3% of net transaction accounts. Banks with a net transaction account of less than $16.3 million were not required to have reserve requirements. The majority of banks in the U.S. fell into the first category. The Fed has set a 0% requirement for non-personal term deposits and euro liabilities. The central bank, which is the country`s largest bank, serves as the banker for all commercial banks in the country. Commercial bank reserves are held by the central bank. These reserves serve as a pool from which the central bank transfers money to commercial banks in times of financial crisis.
The central bank supervises, regulates commercial banks and helps them overcome financial bottlenecks. The minimum amount of reserves a bank must hold is called reserve requirements and is sometimes used as a synonym for the reserve ratio. The reserve requirement ratio is set by Regulation D of the Federal Reserve Board. Regulation D created a uniform set of reserve requirements for all deposit-taking institutions with transaction accounts and requires banks to submit regular reports to the Federal Reserve. The reserve requirement ratio is the portion of reservable liabilities that commercial banks must hold instead of lending or investing. This is a requirement set by the country`s central bank, which in the United States is the Federal Reserve. It is also known as the cash reserve ratio. LRR (Legal Reserve Ratio) refers to the minimum legal proportion of deposits that banks must keep with them in cash. The LRR is determined by the central bank.
It consists of two components:1. Working capital reserve ratio2. Statutory liquidity ratio Banks must hold reserves either in the form of cash in their vaults or in the form of deposits with a federal reserve bank. On October 1, 2008, the Federal Reserve began paying bank interest on these reserves. This interest rate was called the reserve requirement ratio (RIR). There was also an excess interest rate on reserves (IOER), which is paid on all funds a bank deposits with the Federal Reserve and exceeds its reserve requirements. On July 19, 2021, the IORR and IOER were replaced by a new simplified measure, Interest on Reserves (IORB). From 2022, the IRB rate will be 0.10%. The Fed also sets reserve ratios to ensure banks have money to prevent them from running out of money in the event of panicked depositors looking to make mass withdrawals.
If a bank does not have the funds to meet its reserve, it can borrow funds from the Fed to meet the requirement. As a simplified example, suppose the Federal Reserve has set the reserve ratio at 11%. In other words, if a bank has deposits of $1 billion, it must have $110 million in reserve ($1 billion x $0.11 = $110 million). In reserve banks, the reserve ratio is key to understanding how much credit money banks can earn by making deposits. For example, if a bank has $500 million in deposits, it must hold $50 million, or 10%, in reserve. It can then lend the remaining 90%, or $450 million, which will return to the banking system in the form of new deposits. Banks can then lend 90% of this amount, or $405 million, while keeping $45 million in reserves. That $405 million will be repaid, and so on. Ultimately, these $500 million in deposits can be converted into $5 billion in loans, with the 10% reserve requirement defining the so-called monetary multiplier as follows: U.S. commercial banks are required to hold reserves for all their reservable liabilities (deposits) that cannot be loaned by the bank. Recoverable liabilities include net accounts, non-personal term deposits and euro liabilities.
Explain how to treat the estimate of national income, giving the reasons:Purchase of a tractor by a farmer A store of value is the function of an asset that can be stored, recovered and exchanged at a later date and is useful in a predictable way when it is recovered. This is an important function of money. This implies that wealth in the form of money can easily be stored as a medium of exchange for future use. For example, money can be stored in banks to meet emergencies and future needs. The importance of money as a store of value is explained in the following points:1) Money is not ephemeral and its storage costs are also significantly lower.2) It is equally acceptable to everyone at all times.3) Assets can be stored as currency for future use.4) In the trading system, It was very difficult to store goods, especially perishable goods for the purpose of storing value. This limitation of the barter system is overcome by money because of its potential to store value.5) Contractual or future payments were very difficult to make in the exchange system. Money helps people claim and transfer loans and make future and deferred payments and interest. The Board of Governors of the Federal Reserve has exclusive jurisdiction over changes to reserve requirements within the limits set by law. As of 26 March 2020, the minimum reserve was set at 0%. At that time, the board removed the minimum reserve requirement due to the global financial crisis. This means that banks are not obliged to hold deposits with their reserve bank.
Instead, they can use the funds to lend to their customers. Conversely, the Fed increases the reserve requirement to reduce the amount of funds banks must lend. The Fed uses this mechanism to reduce the money supply in the economy and control inflation by slowing the economy. Statutory Liquidity Ratio (SLR): SLR deals with maintaining the asset reserve at RBI, while the cash reserve ratio is for maintaining the cash balance (reserve) at RBI. Thus, SLR is defined as the minimum percentage of assets that must be held in fixed or liquid assets with UBI. The flow of credit is reduced by increasing this liquidity ratio and vice versa. In the previous example, this can be understood as preventing banks from injecting money into the economy, thereby contributing to the reduction of the money supply.
