The following are
the limitations of the method of variable cash reserve ratio:
(i) This method is
not effective when the commercial banks keep very large excessive cash
reserves. In such a case ever if cash reserve 'ratio is raised, ample reserves
remain after satisfying the minimum requirements.
(ii) This method is
not effective when the commercial banks happen to possess large foreign funds.
Thus, even if the central bank reduces the reserves by raising the cash reserve
ratio, these banks will continue to create credit on the basis of the foreign
funds.
(iii) This method is
appropriate only when big changes in the reserves of the commercial banks are
required. It. is not suitable for marginal adjustments in the reserves of the
commercial banks.
(iv) The
effectiveness of this method also depends upon the general mood of the business
community in the economy. A decrease in the cash reserve ratio may not be able
to expand credit during depression because of low future expectations of the
investors.
(v) This method is
discriminatory in nature. It discriminates in favour of the big commercial
banks which, because of their better position, are not much affected by the
changes in the cash reserve ratio as compared with small banks.
(vi) Frequent
changes in the cash reserve ratio are not desirable. They create conditions of
uncertainty for the commercial banks.
(vii) This method
affects only the commercial banking system of the country. The non-banking
financial institutions are not required to maintain cash reserves with the
central bank.
(viii) It is the
most direct and immediate method of credit control and therefore has to be used
very cautiously by the central bank. A slight carelessness in its use may
produce harmful results for the economy.
(ix) This method may
have depressing effect on the securities market. The higher cash reserve
requirements may lead the commercial banks to sell the securities in hand
which, in turn, will reduce their prices in the market.
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