CRR is Cash Reserve Ratio. It refers to keeping a portion of net demand and time liabilities (NDTL) of banks with the central banks (In India it’s Reserve Bank of India, RBI). Central bank fixes this percentage of NDTL. Central bank can change this percentage as a monetary measure to control the availability of funds in the economy i.e. to inject liquidity or to suck liquidity. RBI doesn’t pay any interest on such funds held with it.
The following are the demand liabilities of banks. Banks should pay these liabilities on demand which may come at any time.
All liabilities which are payable on demand; they include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, Demand Drafts (DDs),unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand.
Time Liabilities are those which are payable otherwise than on demand; they include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, deposits held as securities for advances which are not payable on demand and Gold Deposits.
When a central bank increases CRR, the banks need to reduce the outflow of money by reducing the loans to customers and keep additional amount with the central bank. This usually sucks liquidity in the markets. Let’s examine one by one
Stock Market: Some traders take leveraged positions (usually 4 – 5 times their funds) in stock markets by taking additional funds from their brokers at an interest rate. This interest rate goes up as the funds won’t be available easily. When the interest rate goes up they reduce the amount of leverage or they take the same leverage positions but expect more returns from Stock market which is possible only when the prices go down. So the overall effect is prices will go down.
Bond Market: The banks need to increase interest rates to attract more deposits. The prices of the existing bonds will go down because bonds of same profile will be available with higher interest rates.
Over all Economy: Companies find it difficult to raise funds by issuing debentures/bonds because they need to pay more interest. This may cause them to delay the implementation of their expansion plans and the economy slows down.
The above said effects are in general. They may or may not happen at same time and the extent of impact will also depend on the rate of increase in CRR.
Central banks increase CRR only if it feels there is a lot of liquidity in the market and purchasing power of people is more than required (as expected by the central bank) i.e. when the conditions are hyperinflationary.
It reduces the CRR when it feels there is credit crunch in the market and liquidity is very low. The effects will be opposite to the discussed above. This measure is to increase the over all growth rate of the economy.
On October 6th RBI reduced CRR by 0.5% and again on 10th October by 1% to ease the credit crunch in the current market conditions and to make funds available to the banks.
You can find the latest rates from the RBI website itself. Here I am giving the link. Mouse over on reserve ratios (on Right hand side) to see SLR and CRR.