Money deposited in banks incurs a Cash Reserve Ratio (CRR) of 4.5%.
Banks deposit this CRR amount with the Reserve Bank of India (RBI), which locks the money.
The RBI's August Monetary Policy introduced an Incremental CRR (i-CRR) of 10% for deposits after the ₹2000 note ban.
Details
Why i-CRR?: To address the extra deposits that came in post-₹2000 note ban.
Effective Period: Announced in August; the decision to be reviewed on September 8.
Historical Context: Similar steps were taken post-2016 demonetization (₹500 and ₹1000 notes).
UPSC Relevance: Historical precedents indicate such technical measures are rarely asked in exams.
General Advice: Focus on core economic concepts for UPSC preparation.
Basic Concepts
CRR: A portion of bank deposits that must be kept with the RBI.
RBI Loans to Banks: Banks can avail loans from RBI using tools like repo rate and bank rate.
Key Questions Addressed
Why Implement i-CRR?: Manage excess liquidity and its impact on inflation post-₹2000 note ban.
Why Not Increase Normal CRR?: It would have a broader and more significant negative impact on the economy, disrupting GDP growth and money supply. Thus, a temporary i-CRR was preferred.
Why Not Adjust Repo Rate Instead?: Adjusting repo rate broadly affects loan interest rates for consumers, causing widespread financial strain, especially for existing borrowers.
Mechanism of i-CRR
CRR Impact on Deposit Interest: Banks do not earn interest on CRR deposits with RBI.
Inflation Control: By holding more funds as CRR, banks have less money to lend, controlling inflation.
Economic Reasoning
Post-demonetization led to an influx of ₹2000 notes into banks, inflating bank reserves and lowering loan interest rates due to increased loanable funds.
i-CRR helps absorb some excess liquidity, stabilizing inflation and preventing characteristic economic distortions like the Cantillon Effect where only the wealthy benefit from increased money supply.
Normal CRR vs. i-CRR: Increasing normal CRR significantly impacts money multipliers and overall liquidity, hence i-CRR offers a targeted, temporary solution with minimal economic disruption.
Summary
The i-CRR is a targeted measure to manage temporary excess liquidity post-demonetization, focusing on maintaining economic stability without significantly disrupting broader economic indicators.