INCREASE IN CRR

CRR stands for cash reserve ratio. Its a specific amount of deposit that banks have to maintain with Reserve Bank of India. An increase in CRR means banks will have to keep more proportion of lending in the form of deposit which is an opportunity loss for them and thereby decrease in earnings.Banks on their part will have to pay more to depositors to attract them to keep their funds with banks.It will push up the cost of funds for banks and to meet this increased cost and margin pressure ,the banks will have to raise the lending rate.

An increased lending rate will mean an increased cost of capital for the corporate sector.This will lead to contraction in activities and a lower demand in various sectors. For instance: the main reason for skyrocketing real estate prices is availability of easy and cheap funds from banks.But if the bank faces fund crunch , they will first cut back on loans to risky sector like real estate.It will dampen demand to a certain extent.

Some banks on the other hand might face the risk of defaulting in compliance to higher CRR rate. An increased lending rate will hurt the borrowers and hence an accumulation of non permorming loans.

To combat the situation the banks might enter into bilateral deals and ask corporate borrowers to seek refinance from other banks. Another option is to raise funds through External Commercial Borrowings (ECB).