Why in news? RBI to discontinue Incremental Cash Reserve Ratio(I-CRR) in a phased manner

Highlights:

• The I-CRR, was introduced as a temporary measure to manage surplus liquidity
• It was implemented to absorb excess liquidity generated by various factors notably the return of Rs 2000 notes to the banking system
• The decision to discontinue is made to ensure the liquidity remains stable and money market functions in an orderly manner
• Scheduled banks are required to maintain a 10 percent reserve on the increase in their net demand and time liabilities (NDTL)

What is CRR?

• It is the liquid cash that scheduled commercial banks need to keep with RBI as a certain percentage of their demand liabilities. Currently, CRR is at 4.5 per cent.

What is I-CRR?

• Unlike CRR, which applies to the total deposit base, ICRR specifically targets new deposits.
• It is applied to the incremental increase in deposits made by customers within a certain period.
• ICRR is a mechanism through which central banks can regulate the cash reserve requirement of banks when there is excess liquidity through the new deposits.
• RBI earlier used this tool in 2016, when the system was flooded with higher liquidity due to demonetisation.

How Does It Work?

• By imposing higher ICRR on incremental deposits, banks are encouraged to hold a portion of these funds in reserves.
• As liquidity is sucked out, banks will have lesser money to lend, thus bringing down demand for goods and services, thus bringing down prices.
• Short-term interest rates can move higher as the supply of funds get tight in the economy. That is another tool to bring down inflation.
• It contributes to stabilizing the money supply, preventing inflationary pressures, and maintaining financial stability.