Previous Year Question
An increase in CRR by the Reserve Bank of India results in
decrease in debt of the government.
reduction in liquidity in the economy.
attracting more FDI in the country.
more flow of credit to desired sectors.
Correct Answer: B
Detailed Solution
The Cash Reserve Ratio (CRR) is the prescribed percentage of banks' Net Demand and Time Liabilities (NDTL) that they are required to maintain as cash reserves with the Reserve Bank of India.
When the RBI increases the CRR, banks are required to keep a larger portion of their deposits/liabilities as reserves with the RBI. Consequently, the amount of funds available to banks for loans and other investments decreases.
It can be understood simply as—
CRR ↑ → Reserves with RBI ↑ → Banks' lendable funds ↓ → Credit creation ↓ → Liquidity in the economy ↓
Thus, an increase in CRR is a liquidity-absorbing measure. For example, when the RBI increased the CRR from 4.0% to 4.5% in 2022, it stated that the measure would withdraw approximately ₹87,000 crore of liquidity from the banking system.
Conversely, when the CRR is reduced, banks have more funds available for lending and liquidity in the banking system can increase. In December 2024, the RBI estimated that a CRR reduction would release approximately ₹1.16 lakh crore of primary liquidity into the banking system.