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India’s central bank, the Reserve Bank of India, dropped the country’s reserve ratio from 9.0 percent to 7.5 percent Oct. 10. In doing so, New Delhi is attempting to free up capital to alleviate the credit crisis — but it is also risking a deeper crisis in its banking system.
Banks use their depositors’ money to earn income, lending it out to their clients at a higher rate of interest than they grant to their depositors. In order to provide a bulwark against instability, governments require that banks do not loan out all of their deposits, however, forcing them to hold a percentage of those deposits in reserve in cash. That supply of money is called a reserve requirement (or reserve ratio).
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