Consider the following statements about Cash Reserve Ratio (CRR):
1. The CRR affects the credit creation capacity of commercial banks.
2. An increase in CRR leads to a decrease in the money supply and may reduce inflationary pressures.
Which of the above statements is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Explanation Statement 1 is correct : The Cash Reserve Ratio (CRR) is the percentage of a bank's total deposits that it must maintain as reserves with the Reserve Bank of India (RBI). Since this reserve is not available for lending, the higher the CRR, the less money banks have to lend. As a result, CRR directly affects the credit creation capacity of commercial banks. An increase in CRR reduces the ability of banks to extend credit, while a decrease in CRR increases it.
Statement 2 is correct : When the CRR is increased, commercial banks must hold a larger portion of their deposits as reserves with the RBI. This means they have less money available to lend, which reduces the overall money supply in the economy. With a reduced money supply, demand for goods and services falls, helping to control inflationary pressures.
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