What is Cash Reserve Ratio?
CRR (Cash Reserve Ratio) is the share of bank’s total deposit that it needs to maintain (or keep) with RBI in form of cash.
As per RBI guidelines, banks are required to maintain with RBI, a part (ratio) of their total deposits. These deposits can also be held with currency chests, which are considered as equivalent to keeping with RBI.
This ratio (CRR) is changed by RBI from time to time. By changing CRR, RBI can effectively drain excess liquidity from the system, or supply money to the system for economic growth. Let’s understand this with an example. Suppose a bank has 100 Lakh Rupees. Under normal circumstances, it could have lent this 100 Lakhs to public. But there is mandate of keeping a certain ratio of this 100 Lakhs (aka CRR) with RBI. Suppose CRR is 4%. So, Banks need to keep 4% of this 100 Lakhs (i.e. 4 Lakhs) with RBI. Hence, Banks are left with only 96 Lakhs to lend to public. In this way, Banks effectively control the lending power of the Banks.
In other words, “higher the CRR, lower the amount available to banks for lending/investing”.
Now the question arises – Why RBI changes the CRR rate?
- to ensure that a portion of Bank’s deposit is in safe hands i.e with RBI
- to control liquidity in the system and combat Inflation
Limits: Earlier, the CRR limit was between 3 percent to 20 percent. RBI could earlier change the CRR within this limit. However, as per the Reserve Bank of India (Amendment) Bill 2006, this limit was removed.
What is Statutory Liquidity Ratio
SLR (Statutory Liquidity Ratio) is the share of bank’s total deposit that it needs to maintain (or keep) with itself as liquid assets.
As per RBI guidelines, Banks are required to maintain a part (ratio) of their total deposit (NTDL) as liquid assets. These assets include gold, cash, government securities and other approved securities. For example, if a Bank has 100 Lakh Rupees and SLR is 25%, then 25 Lakhs of these 100 Lakhs will be with kept with banks as gold, cash, government securities, etc.
In other words, higher the SLR, lower the leverage for banks for credit expansion.
Now, Why RBI changes SLR?
- to control the credit expansion by Banks.
- to ensure the solvency of Banks.
- to compel the Banks to invest in government securities like government bonds.
Limits: The upper limit of SLR is 40% while the lower limit is 23%
Differences between SLR & CRR ?
By this time, you might be wondering what’s the exact difference between SLR and CRR.
- CRR controls the liquidity in Banking system. Whereas SLR controls the leverage Banks have for credit expansion
- CRR is maintained only in Cash. While SLR can be maintained in any liquid assets including cash and gold.
- CRR is maintained with RBI. SLR is the money Banks keep with themselves in liquid asset.