If inflation in the economy is rising uncontrollably, the Reserve Bank of India (RBI) may decide to increase the Cash Reserve Ratio (CRR). What is the likely consequence of this action?
(a) Increase in the liquidity in the banking system.
(b) Reduction in the liquidity available to banks for lending.
(c) No significant change in the availability of credit.
(d) Increase in the interest rates on loans.
Explanation Option a is not correct: An increase in the Cash Reserve Ratio (CRR) means banks have to keep a higher percentage of their deposits with the RBI. This reduces the funds available with banks for lending or investment, thereby reducing liquidity in the banking system—not increasing it.
Option b is correct : When the Reserve Bank of India (RBI) increases the Cash Reserve Ratio (CRR), it means that commercial banks are required to keep a larger portion of their deposits with the RBI in the form of reserves. This reduces the amount of money banks have available to lend out to consumers or businesses. As a result, the liquidity in the banking system decreases, which typically helps in controlling inflation by restricting the availability of credit.
Option c is not correct: A change in the CRR directly impacts the amount of credit available. Increasing the CRR reduces the ability of banks to lend money, leading to a reduction in credit availability.
Option d is not correct : While increasing the CRR might reduce liquidity, which could indirectly lead to higher interest rates due to a tightening of credit, the direct consequence of increasing CRR is the reduction in liquidity, not the direct increase in interest rates. However, the reduction in credit may lead to an upward pressure on interest rates over time.
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