If the Cash Reserve Ratio is lowered by the RBI, supply of money in the economy will:

Correct — C, increase. The Cash Reserve Ratio is the share of a bank's net demand and time liabilities that it has to park as cash balances with the RBI, where it earns nothing and cannot be lent. Lowering that share does two things at once. It releases the reserves already locked up, handing banks fresh lendable funds on the same deposit base. And it raises the money multiplier itself, since the multiplier is 1 divided by the sum of the public's currency-to-deposit ratio and the banks' reserve ratio — shrink the reserve ratio and each rupee of high-powered money supports a larger stock of deposits. Fresh loans become fresh deposits, those deposits fund further loans, and broad money expands. A CRR cut is the textbook expansionary quantity tool.

• (a)remain unchanged. — This would require banks to hold the released cash idle as excess reserves and lend none of it. Even in that unlikely case the reserve ratio in the multiplier has fallen, so the money-supply relation has already shifted upward.
• (b)decrease. — That is the effect of raising the CRR, not lowering it. A higher ratio drains cash from banks to the RBI and squeezes the credit they can create.
• (d)have ambiguous impact. — The size of the effect is uncertain, since it depends on how much demand for credit there is, but the direction is not. In the standard model a lower reserve requirement can only push the money supply up or leave it where it was.

Money supply in a fractional-reserve system is high-powered money multiplied up by the banking system. High-powered money is currency with the public plus the reserves banks hold with the central bank. Every rupee of deposit that a bank need not keep in reserve can be lent, and the borrower's spending returns to the system as somebody else's deposit, which supports further lending. The reserve requirement fixes how far that chain can run, so the central bank controls the multiplier by moving the requirement even when it leaves interest rates alone.

Keep the quantity tools and the price tool apart. The CRR, the Statutory Liquidity Ratio and open market operations act on how much money there is; the repo rate acts on what it costs. The CRR and SLR are also not the same instrument wearing different names — CRR balances are cash sitting with the RBI and earn no interest, while SLR assets stay on the bank's own books as government securities, gold or cash and keep earning a return. At the time of the August 2023 exam the CRR stood at 4.5 per cent of net demand and time liabilities, after a half-point increase in May 2022. The RBI has moved it since, so read the current figure off the latest monetary policy statement rather than from memory.

• The CRR is the fraction of net demand and time liabilities a bank must keep as cash balances with the RBI, and those balances earn no interest.
• The money multiplier is 1 divided by the sum of the currency-deposit ratio and the reserve ratio, so a lower reserve ratio raises it.
• SLR assets stay with the bank as government securities, gold or cash and earn a return, which is the main practical difference from CRR.
• Section 42 of the Reserve Bank of India Act, 1934 is the statutory basis of the CRR; the SLR comes from Section 24 of the Banking Regulation Act, 1949.
• The CRR stood at 4.5 per cent of net demand and time liabilities at the time of the 2023 exam.

• Reading a CRR cut as contractionary because reserves sound protective.
• Treating CRR and SLR as interchangeable when only one of them moves cash to the RBI.
• Assuming a quantity tool must move the repo rate as well; the two are used independently.

Asked as a direction-of-effect item — one instrument moves one way, and the candidate has to name what happens to the aggregate.

• practice — not a real PYQ

  Which one of the following is held by a commercial bank itself rather than with the Reserve Bank of India?

  • (a)Cash Reserve Ratio balances
  • (b)Statutory Liquidity Ratio assets
  • (c)Both of them
  • (d)Neither of them

  Answer(b) Statutory Liquidity Ratio assets — SLR is maintained by the bank in government securities, gold or cash on its own books, while CRR balances sit as cash with the RBI.

• practice — not a real PYQ

  If the currency-deposit ratio of the public rises while the reserve ratio stays the same, the money multiplier will

  • (a)rise
  • (b)fall
  • (c)stay the same
  • (d)become zero

  Answer(b) fall — the multiplier is 1 divided by the sum of the two ratios, so a larger currency-deposit ratio enlarges the denominator and shrinks the multiplier.