Reserve Ratios(CRR and SLR), Money Multiplier

Definition: Also known as Cash Reserve Ratio, it is the percentage of deposits which commercial banks are required to keep as cash according to the directions of the central bank, with the central bank, and not within their own banks.

Description: The reserve ratio is an important tool of the monetary policy of an economy and plays an essential role in regulating the money supply. When the central bank wants to increase money supply in the economy, it lowers the reserve ratio. As a result, commercial banks have higher funds to disburse as loans, thereby increasing the money supply in an economy.

On the other hand, for controlling inflation, the CRR is generally increased, thereby decreasing the lending power of banks, which in turn reduces the money supply in an economy.

 

STATUTORY LIQUIDITY RATIO (SLR)

  • SLR is the Indian government term for reserve requirement that the commercial banks in India require to maintain in the form of gold or government approved securities before providing credit to the customers.
  • SLR is determined by Reserve Bank of India, but maintained by banks in order to control the expansion of bank credit.
  • The SLR requirement is to be maintained within the bank’s vaults and not with the rbi, which is the case in CRR.
  • Banks have to report to the RBI every alternate Friday, their SLR maintenance, and pay penalties for failing to maintain SLR as mandated.
  • The SLR is determined by a percentage of total demand and time liabilities.
  • Time Liabilities refer to the liabilities which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon, and demand liabilities are such deposits of the customers which are payable on demand.
  • An example of time liability is a six month fixed deposit which is not payable on demand but only after six months. An example of demand liability is a deposit maintained in saving account or current account that is payable on demand through a withdrawal form such as a cheque.

How is SLR maintained?

The eligible assets for SLR mainly include cash, gold and approved securities by the RBI. Most banks keep the SLR in the form of approved securities, specifically –central government bonds and treasury bills as they give a reasonable return.

As per December 10, 2015 notification by the RBI, for Scheduled Commercial Banks, the SLR should be in the form of:

a) in cash, or

b) in gold valued at a price not exceeding the current market price, or

(c) Unencumbered investment in any of the following instruments, namely:-

  • Dated securities of the Government of India or
  • Treasury Bills of the Government of India; or
  • State Development Loans (SDLs) of the State Governments

(d) The deposit and unencumbered approved securities required to be made with the Reserve Bank by a banking company incorporated outside India;

(e) Any balance maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be maintained by it under section 42 of the Reserve Bank of India Act. 

Difference between CRR and SLR

  • The money that is to be set aside as SLR is predominantly invested in government-approved securities (bonds), Gold, which mean the banks can earn some amount as ‘interest’ on these investments as against CRR where they do not earn anything.
  • The SLR requirement is to be maintained within the bank’s vaults and not with the rbi, which is the case in CRR.
  • Cash Reserve Ratio is the percentage of the deposit (NDTL) that a bank has to keep with the RBI. CRR is kept in the form of cash and that also with the RBI. No interest is paid on such reserves.
  • On the other hand, SLR is the percentage of deposit that the banks have to keep as liquid assets in their own vault.
  • The CRR is a more active and useful monetary policy weapon compared to the SLR. Nowadays, the RBI changes CRR to manage liquidity in the economy.

Why these reserve requirements?

Primarily to ensure that banks always have enough liquidity (cash and cash equivalent securities) to honour depositor’s demands and that they don’t lend away all their funds.

Money Multiplier