Cash reserve ratio and its significance

 

Cash reserve ratio (CRR) is an important metrics to all commercial and microfinance banks. The ratio tells banks the amount of their total deposits they must keep in their vault and with the central bank. Before now, banks do face sanction if they fail to comply with the CBN direction on it. The CRR is a monetary policy measurement that must be complied by all commercial banks. Below, we explain this term and its significance.

What is Cash Reserve Ratio (CRR)?

The cash reserve ratio is the ratio of the total deposits in a bank that must not be used by them or loaned out to other businesses. It is a mandatory requirement by the central bank and failure by a bank to comply can result to sanction by the central bank. The fraction of the total deposits that is kept as CRR is in the vault of the banks and the central bank.

A CRR is a portion of the total deposit. These deposits include demand, savings and fixed deposits accounts. All deposited money in the accounts is added up and a fraction of it is kept within and the apex bank. It is the remainder that is used by commercial banks to carry out their business and make profit. In Nigeria, the Central Bank decides the CRR and is subject to change from period to period.

During the monetary policy meetings, the Central bank of Nigeria (CBN) can either increase the rate or reduce it. This makes it an economic barometer. And it is used to control the money supply in the country. Banks that failed to comply with the mandatory guideline are sanction by the CBN. 

This is done by compulsory debits of those banks at the end of the months. However, the new CBN guideline shows that the CBN will no longer debits commercial banks for not meeting their CRR requirements but will work with them to ensure that it is complied with by commercial banks.

Significance of Cash Reserve Ratio

The use of cash reserve ratio for banks has positive significance on them. It aids banks’ liquidity, therefore avoid bank runs. Below, we explain some key impacts on CRR on money deposit banks.

Control of money supply

CRR helps to control money supply. The Bank can use the mechanism to either increase or reduce money supply. If the apex bank wants to increase money supply, it will decrease the rate and increase the percentage when its goal is to reduce money supply.

Inflation management

The apex bank can use the rate to manage inflation. This is done via monetary policy committee meetings in Nigeria. The rate can be increase or decrease to manage inflationary issues. However, the cause of the inflation should be accessed before deciding on if it can be corrected via monetary or fiscal policies.

Bank run

Lack of cash in the banks can lead to bank run. Customers may want to collect their deposited cash and will not be able to do so because of the lack of funds at the bank. The goal of the cash reserve ratio is to ensure that there are always funds to meet customers daily withdrawal needs.

Loans from banks

The CRR can impact on bank's ability to give out loans. A large ratio means small funds available for loans from banks. This will reduce banks’ earnings and protect their deposit customers. However, the scarcity of cash can force banks to increase loan interest rate. Therefore, attracting the wealthy who can pay the cost.