A scheduled bank is under an obligation to keep a cash Reserve, called the statutory Cash Reserve, with the Reserve bank under Section 42 of the Reserve Bank of India Act, 1934. Every scheduled bank is required to maintain with the Reserve bank an average daily balance equal to at least 3% of its net demand and time liabilities. Average daily balance means the average of balances held at the close of business on each day of the fortnight. The Reserve Bank is empowered to increase the rate of statutory cash serve from 3% up to 20% of the net liabilities.
Interest rate on CRR:
Reserve Bank of India pays interest to the scheduled banks on their cash reserves maintained with it (in excess of the statutory minimum of 3 percent). The rate of interest was gradually raised till it reached the level of 10.5% per annum. Therefore, from April 12, 1990 interest on bank’s cash balances with the Reserve bank was paid on a two tier formula as follows:
1. @ 10.5% p.a. on the eligible cash balances based on the net demand and time liabilities as on March 23, 1990; and
2. On the eligible cash balances on the basis of increase in net demand and time liabilities after March 23, 1990 no interest was payable since October 9, 1992.
The system of payment of interest on CRR was rationalized with effect from October 25, 1997. Reserve Bank of India fixed the rate of interest at 4% per annum on all the eligible cash balances maintained by banks with it under Section 42 of the Reserve Bank of India Act. With effect from April21, 2001 interest on eligible balances was raised to 6 per cent per annum. Reserve Bank of India linked the rate of interest paid on CRR wit the bank rate subsequently and hence it was raised to 6.5% w.e.f Nov.3, 2001.
Changes in Statutory Cash Reserve with Reserve Bank (Post 1993):
The Reserve Bank of India accepted the recommendation of Narasimham Committee on the Financial Sector that Reserve Bank of India should consider progressively reducing the CRR from the high level. In its opinion the Reserve bank should have the flexibility to operate the instrument of CRR to serve the monetary policy objectives.
In its credit policy for 1993-94, the Reserve bank of India reduced CRR maintained by scheduled commercial banks from 15% to 14% in two phases. Certificate of Deposits issued by banks over the pre-may, 1992 level were made subject to CRR.
The main objective of this reduction was to enlarge the availability of credit to trade and industry which was felt necessary for strong industrial revival. Such reduction was expected to augment lend able resources of banks by about Rs 2,800 crores for meeting the credit requirements of the productive sectors of the economy.
In April, 1997 Reserve Bank of India made the following modifications in the requirements of CRR:
1. Net inter-bank liabilities of a bank (i.e. liabilities of a Bank towards all other banks as reduced by the liabilities of all other banks to the bank concerned) were exempted from CRR. This step was taken to develop term money market.
2. CRR @ 10% imposed on the increase in liabilities under FCNR (B) Scheme, NRE (Accounts) Scheme and NRNR Accounts Scheme over the level outstanding as on April 11, 1997.
On October 21, 1997 Reserve bank of India announced reduction n CRR by 2 percentage points to 8% in eight phases of 0.l25% each. Consequently, it declined to 9.5% on November 22, 1997 after the second phase of reduction. But on December 6, 1997 CRR was hiked to 10% in the face of the falling external value of the rupee. Reserve Bank so did away with CRR requirements of NRE and NRNR rupee deposits to attract more dollar funds through these deposits. CRR was raised to push up the cost to short term money to break the arbitrage between the money and foreign exchange markets.