Effect of Decrease in Cash Reserve Ratio
Effect on interest rates: When the cash reserve ratio is decreased by the RBI, banks will have more money to invest in other businesses since the amount of funds that needs to be kept with the RBI is low. This shows that banks will have an excess of funds and hence, there will be a decline in the interest rates that are charged on loans.
Effect on inflation: When the cash reserve ratio is minimised, commercial banks will have more funds and hence, the money supply of the banking system will increase. When there is a rise in the money supply, excessive funds will result in high inflation.
When the CRR is minimised, funds are drawn out from the economic system excessively and then the money supply is affected negatively wherein there is a shortage of funds. Since the money supply has declined in this situation, the inflation also reduces.
Effect of Increase in Cash Reserve Ratio
When the cash reserve ratio is raised, banks will have very limited amount of funds because they are asked to retain huge amounts of cash in hand with the Reserve Bank of India. Hence, banks will not have any money to use for other purposes. You also need to remember that the RBI does not pay any interest on balances of the CRR.
Now, since banks are not able to receive any interest, they decide to raise the interest rates. They will be forced to raise the interest rates for their loan products such as personal loans, car loans, home loans, two-wheeler loans, etc. When interest rates are increased, even the equated monthly installments (EMIs) of the borrowers will increase. Your loan costs will rise pretty intensely.
Effect on interest rates: When the cash reserve ratio is decreased by the RBI, banks will have more money to invest in other businesses since the amount of funds that needs to be kept with the RBI is low. This shows that banks will have an excess of funds and hence, there will be a decline in the interest rates that are charged on loans.
Effect on inflation: When the cash reserve ratio is minimised, commercial banks will have more funds and hence, the money supply of the banking system will increase. When there is a rise in the money supply, excessive funds will result in high inflation.
When the CRR is minimised, funds are drawn out from the economic system excessively and then the money supply is affected negatively wherein there is a shortage of funds. Since the money supply has declined in this situation, the inflation also reduces.
Effect of Increase in Cash Reserve Ratio
When the cash reserve ratio is raised, banks will have very limited amount of funds because they are asked to retain huge amounts of cash in hand with the Reserve Bank of India. Hence, banks will not have any money to use for other purposes. You also need to remember that the RBI does not pay any interest on balances of the CRR.
Now, since banks are not able to receive any interest, they decide to raise the interest rates. They will be forced to raise the interest rates for their loan products such as personal loans, car loans, home loans, two-wheeler loans, etc. When interest rates are increased, even the equated monthly installments (EMIs) of the borrowers will increase. Your loan costs will rise pretty intensely.
