UPSC Prelims 2010 Q81: Indian Economy – Monetary Policy & Money Supply
When the Reserve Bank of India announces an increase of the Cash Reserve Ratio, what does
it mean?
- (a) The commercial banks will have less money to lend
- (b) The Reserve Bank of India will have less money to lend
- (c) The Union Government will have less money to lend
- (d) The commercial banks will have more money to lend
Answer: (a) The commercial banks will have less money to lend
Explanation
What a CRR increase by the RBI means
The Cash Reserve Ratio (CRR) is the percentage of deposits banks must keep with the RBI, unavailable for lending.
| Option | Verdict | Reason |
|---|---|---|
| (a) Commercial banks will have less money to lend | Correct | A higher CRR means banks must park more of their deposits with the RBI, directly reducing the funds available for lending |
| (b) The RBI will have less money to lend | Incorrect | The RBI isn't a lender to the public in this context; raising CRR affects commercial banks' lendable funds, not the RBI's |
| (c) The Union Government will have less money to lend | Incorrect | CRR changes affect commercial banks, not the government's own lending capacity |
| (d) Commercial banks will have more money to lend | Incorrect | This is the opposite effect; a CRR increase reduces, not increases, lendable funds |
CRR mechanism:
| Point | Detail |
|---|---|
| CRR increase | Banks park more funds with RBI |
| Effect | Less money available for banks to lend |
| Purpose | Tighten liquidity, often to control inflation |
Answer: (a) The commercial banks will have less money to lend.
Why each option is right or wrong
- (a) CORRECT. A CRR increase forces banks to hold more reserves with the RBI, reducing their lendable funds.
- (b) Incorrect. The RBI is not a direct lender in this context; the effect is on commercial banks' funds.
- (c) Incorrect. CRR changes don't directly affect the Union Government's own lending capacity.
- (d) Incorrect. This is the opposite of the actual effect — CRR increase REDUCES lendable funds.
Key point
A CRR increase means commercial banks must keep more funds with the RBI, directly REDUCING the money available for them to lend — a standard liquidity-tightening tool.
Remember
RBI raises CRR → commercial banks have LESS money to lend (tighter liquidity).
Common mistakes
- Reversing the effect, thinking a CRR increase gives banks more lendable funds.
- Confusing the RBI's regulatory role with being a direct lender itself.
- Mixing up CRR's effect on commercial banks with an effect on government lending capacity.
Exam tip
CRR increase = banks park MORE with RBI = LESS money to lend. A fundamental monetary-policy mechanism, often tested in reverse-logic traps.
Sources
- Reserve Bank of India — Master Circular on Statutory Pre-emptions: Cash Reserve Ratio
- Reserve Bank of India Act, 1934, Section 42 (Cash Reserve Ratio)