WHAT IS CASH RESERVE RATIO:

• A cash reserve ratio (or CRR) is the percentage of bank reserves to deposits and notes. The cash reserve ratio is also known as the cash asset ratio or liquidity ratio. A legal obligation on banks to maintain certain reserves in the form of cash with Reserve Bank of India. The reserves, to be maintained over a fortnight, are computed as a percentage

• Of a banks net demand and time liabilities. banks earn interest on eligible cash balances thus maintained and it contributes to their profitability. However such interest payment tends to attenuate monetary control and hence these outflows need to be moderated if the situation so demands. An alternative that has been suggested is to fix a lower level of reserves and pay a modest interest.

RESERVE REQUIREMENT:

• The reserve requirement (or required reserve ratio) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault (vault cash), or with a central bank.

• The reserve ratio is sometimes used as a tool in monetary policy, influencing the country's economy, borrowing, and interest rates.Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they prefer to use open market operations to implement their

• monetary policy. The People's Bank of China does use changes in reserve requirements as an inflation-fighting tool, and raised the reserve requirement nine times in 2007. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits (component of money supply "M1"), and zero on time deposits and all other deposits.

• An institution that holds reserves in excess of the required amount is said to hold excess reserves.

EFFECTS ON MONEY SUPPLY:

• Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81

• As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000), e.g.$100/0.10=$1,000. In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of ($100+$80+$64+$51.20+...=$500), e.g.$100/0.20=$500.

• Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.

• Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money.

• NEW DELHI, Oct. 16 -- In a major move to inject liquidity into the financial system, the Reserve Bank of India (RBI), India's central bank, on Wednesday announced to reduce the Cash Reserve Ratio (CRR) by 100 basis points to 6.5 percent, the local media reported Thursday.

• This will help release additional 400 billion rupees, or 8 billion U.S. dollars to the banking system.