What is the limitations of Variable Cash Reserve Ratio?



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.