On August 10, the Reserve Bank of India (RBI) asked banks to maintain an incremental Cash Reserve Ratio (ICRR) of 10 per cent on the increase in their deposits between May 19 and July 28.
What is ICRR?
Incremental Cash Reserve Ratio (ICRR) is a temporary measure employed by the Reserve Bank of India (RBI) to drain off excess liquidity from the banking system. It is a percentage of the increase in a bank’s net demand and time liabilities (NDTL) that the bank has to maintain as cash reserve with the RBI.
The ICRR was introduced in India in 2016, soon after the demonetisation of Rs 500 and Rs 1000 notes. The RBI imposed an ICRR of 100% on the increase in NDTL of banks between September 16 and November 11, 2016. This was done to absorb the surplus liquidity that had entered the banking system due to the deposit of demonetised notes.
The ICRR was again imposed by the RBI in August 2023, this time at a rate of 10%. This was done to absorb the surplus liquidity that had entered the banking system due to the deposit of Rs 2000 currency notes.
The ICRR has a significant impact on liquidity in the banking system. When the ICRR is high, it means that banks have to keep more of their deposits as cash reserve with the RBI. This reduces the amount of money that banks have available to lend to businesses and consumers. This can lead to a slowdown in economic activity.
However, the ICRR can also be used to control inflation. When the RBI increases the ICRR, it reduces the amount of money that is available in the economy. This can help to cool down inflation.
The ICRR is a powerful tool that the RBI can use to manage liquidity and inflation in the economy. However, it is important to use it judiciously, as it can also have a negative impact on economic growth.
| ICRR | Impact on liquidity |
|---|---|
| Low | Increased liquidity |
| High | Decreased liquidity |
Incremental Cash Reserve Ratio (ICRR) is a temporary measure employed by the Reserve Bank of India (RBI) to drain off excess liquidity from the banking system. It is a percentage of the increase in a bank’s net demand and time liabilities (NDTL) that the bank has to maintain as cash reserve with the RBI.
The ICRR was introduced in India in 2016, soon after the demonetisation of Rs 500 and Rs 1000 notes. The RBI imposed an ICRR of 100% on the increase in NDTL of banks between September 16 and November 11, 2016. This was done to absorb the surplus liquidity that had entered the banking system due to the deposit of demonetised notes.
The ICRR was again imposed by the RBI in August 2023, this time at a rate of 10%. This was done to absorb the surplus liquidity that had entered the banking system due to the deposit of Rs 2000 currency notes.
The ICRR has a significant impact on liquidity in the banking system. When the ICRR is high, it means that banks have to keep more of their deposits as cash reserve with the RBI. This reduces the amount of money that banks have available to lend to businesses and consumers. This can lead to a slowdown in economic activity.
However, the ICRR can also be used to control inflation. When the RBI increases the ICRR, it reduces the amount of money that is available in the economy. This can help to cool down inflation.
The ICRR is a powerful tool that the RBI can use to manage liquidity and inflation in the economy. However, it is important to use it judiciously, as it can also have a negative impact on economic growth.
Here is a table showing the impact of ICRR on liquidity:
| ICRR | Impact on liquidity |
|---|---|
| Low | Increased liquidity |
| High | Decreased liquidity |
The ICRR is a temporary measure that is usually imposed for a short period of time. Once the RBI is satisfied that the surplus liquidity in the system has been absorbed, it will revise the ICRR downward. This will help to increase liquidity in the banking system and boost economic activity.
Banks react negatively when ICRR is increased by the RBI because it reduces the amount of money that they have available to lend to businesses and consumers. This can lead to a slowdown in economic activity.
Here are some of the reasons why banks react negatively to an increase in ICRR:
- It reduces the amount of money that banks have available to lend. When banks have less money to lend, they are less likely to approve loans, which can make it difficult for businesses to expand and for consumers to buy homes and cars. This can lead to a slowdown in economic activity.
- It increases the cost of lending. When banks have to keep more of their deposits as cash reserve with the RBI, they have to borrow money from other banks to meet their lending requirements. This can increase the cost of lending, which can make it more expensive for businesses and consumers to borrow money.
- It reduces the profitability of banks. When banks have less money to lend and when the cost of lending increases, their profits can decline. This can make it difficult for banks to attract new investors and to raise capital.
The RBI usually increases the ICRR when there is too much liquidity in the banking system. This can happen when there is a lot of money in the economy, such as after a big government spending programme or a surge in exports. When there is too much liquidity in the banking system, it can lead to inflation. The RBI increases the ICRR to soak up some of the excess liquidity and to prevent inflation from rising.
However, an increase in the ICRR can also have negative consequences for the economy. It can lead to a slowdown in economic activity, increase the cost of lending, and reduce the profitability of banks. The RBI needs to carefully weigh the pros and cons of increasing the ICRR before taking action.