Explain the role of Cash Reserve Ratio in controlling credit creation.
Solution
Cash reserve ratio (CRR) is the necessary minimum percentage of a bank’s total deposits which is to be kept with the Central Bank. Commercial banks need to maintain with the Central Bank a certain percentage of their deposits in the form of cash reserves. The Central Bank can vary CRR between 3% and 15%. When they hold a large portion of their deposits as CRR, it reduces the provision of credits to the public. This leads to a decline in the demand for loans and consumption expenditure. Thus, it leads to a fall in the supply of money. While they hold a less portion of their deposits as CRR, it increases the provisions of credit to the public. This in turn increases the supply of money in an economy.
