Requirement of reserves acts as a limit to money (credit) creation. This is determined by the central Bank (RBI). The RBI decides a certain percentage of deposits which every bank must keep as reserves. This is done to ensure that no bank is ‘over lending’. This is a legal requirement and is binding on the banks. This is called the ‘Required Reserve Ratio’ of the ‘Reserve Ratio’ or ‘Cash Reserve Ratio’ (CRR).
CRR is the percentage of deposits which a bank has to maintain with the RBI and Certain portion of reserves it has to keep with itself in the form of liquid assets which is also called as Statutory Liquidity Ratio (SLR).
For example, if a Bank receives ₹100 as deposit and CRR is 20%, then with deposit of ₹100, the bank will need to keep ₹20 as cash reserve. Only the remaining amount of deposits ₹80 can be used to give loans.
These tools play an important role today for controlling the supply of money in the economy and to have a price stabilization and stability in the economy.