You are on page 1of 9

ROLE OF CRR AND SLR

IN INDIAN ECONOMY






FINANCIAL LAW AND POLICY
COURSE: LL.M.
BATCH: 2013-14
SUBMITTED BY: VINEETA SINGH
20131391


ROLE OF CRR AND SLR IN INDIAN ECONOMY


INTRODUCTION:
Borrowing and lending in the financial market depend to a significant extent on the rate of
interest. Internal and external credit risk rating systems are becoming increasingly important
element of large commercial banks measurements and management of credit risk both
individual exposures and portfolios. They play a major role in shaping the monetary structure
of the economy. In Indian economy the structuring of the finance is being done by the central
bank I.e. RBI (Reserve Bank of India). It adopts the certain tools such as CRR and SLR
applicable in the relationship of commercial banks and RBI, which are being used to conduct
its monetary policy.
This paper aims to provide knowledge and understanding of these ratios, how BASEL would
affect the ratios, role of RBI in the regulation of these ratios and lastly, the impact it would
create on the Indian economy.
RBI is the central bank which regulates the monetary policy of India. Its main objective is to
maintain price stability and ensuring adequate flow of credit in productive areas. It regulates
the money and credit through appropriation monetary and credit policies followed regularly.
Its one of the duty is to control the credit through CRR, bank rate and open market
operation. RBI issues circulars time to time which contains the guidelines for the banks on
matter relating to maintenance of CRR and SLR. It has the authority to set reserve
requirements i.e. the banks are required to maintain a certain percentage of deposits in their
own vaults or deposit the same in RBI. It has been seen that when the reserve requirement is
raised the commercial banks will be left with less cash and therefore, they have to credit but


if this limit is reduced, the commercial banks will have more cash with them and they would
be able to lend more money in the market.
BASEL is a committee of 27 member nation for common goal of financial stability and
common standards of banking regulations. The purpose behind it is to ensure that financial
institutions have enough capital on account to meet obligations and absorb unexpected losses.
India adopted this BASEL norm as one of its reform towards banking sector with a view to
strengthen their banking sector. First capital accord published by this committee was 1988
BASEL Capital Accord, and then came BASEL II into picture as the first accord was only
for capital risk charge. BASEL-II was intended to create an international standard on capital
adequacy for banking regulators (chapter 18 tannans banking 23
rd
ed.2012), to maintain
sufficient consistency of regulations and to protect the international financial system. It
proposed to work on three pillars: maintaining minimum capital requirement, undertaking
supervisory renew of bank capital and effective use of market discipline. Basel committee
introduced BASEL-III in 2010 after the financial crisis of 2008 they felt the need for further
strengthening the banking system in member nations. The guidelines under this accord aim to
promote a more resilient banking system focusing on leverage, capital, funding and liquidity.
(basel site)

CASH RESERVE RATIO(CRR)

CRR stands for cash reserve ratio. It is the per cent of amount or deposits that a bank is
required to maintain in their own vaults or an amount they must have in their hands in cash.
The main reason to maintain the CRR is to keep a bank liquid at any point of time. Whenever
a bank keep low CRR it increases the availability of the money with the bank for credit in the
system and also enables RBI to control liquidity in the system. Section 42 (1) of RBI Act
1934( after RBI amendment bill 2006) provides that the Reserve Bank, having regard to the


needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve
Ratio (CRR) for scheduled banks without any floor rate or ceiling rate.(rbi site) Before the
amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR
for scheduled banks between 3 per cent and 20 per cent of total of their demand and time
liabilities ( DTL).The present rate of CRR is 4% of the banks total of demand and time
liabilities, effective from February 09, 2013. That means scheduled banks are required to
maintain with the RBI an average cash balance, the amount of which shall not be less than
4% of the total of the Net Demand and Time Liabilities (NDTL).
Section 42(1-A) of RBI Act, 1934, the SCBs are required to maintain, in addition to the
balances prescribed under Section 42(1) of the Act, an additional average daily balance, the
amount of which shall not be less than the rate specified by the Reserve Bank in the
notification published in the Gazette of India from time to time. Such additional balance will
be calculated with reference to the excess of the total of DTL of the bank as shown in the
Returns referred to in Section 42(2) of the RBI Act, 1934 over the total of its DTL at the
close of the business on the date specified in the notification. (rbi site) Currently, no
incremental CRR is required to be maintained by the scheduled banks. RBI prescribes the
method to compute the CRR under section 24(2) (b) of banking regulation act, 1949.

STATUTORY LIQUIDITY RATIO(SLR)

SLR stands for statutory liquidated ratio or reserve. The scheduled commercial banks are
required to maintain a percentage of liquid assets or SLR. These assets although considered
liquid in nature but in reality they are not liquid because the maintenance of this reserve is a
statutory obligation on the bank and failure may result into penalties on bank to pay. It is that
amount which a bank has to maintain in the form of cash, gold or approved securities. The
quantum is specified as minimum proportion of the total demand and time liabilities of a


bank. The percentage of SLR is fixed by RBI and demand and time liabilities (DTL) of the
bank are calculated on the last Friday of the preceding fortnight. The value of these assets of
a scheduled commercial bank shall not be less than 4 % (such percentage as fixed by RBI)
not exceeding 40 per cent of its total DTL in India as on the last Friday of the second
preceding fortnight as the Reserve Bank may, by notification in the Official Gazette, specify
from time to time.
(http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?Id=8117&Mode=0#11)
As per section 42 of RBI Act every scheduled commercial bank (SCBs) in India is required to
maintain a certain proportion of their net demand and time liabilities as assets in: - cash or
gold valued at price not exceeding the current market price or unencumbered approved
securities valued at a price as specified by the RBI from time to time. Section 24 (2) (B) of
Banking Regulation Act 1949 provides the procedure to compute total net demand and time
liabilities for the purpose of SLR.

DIFFERENCE BETWEEN CRR AND SLR

Meaning: CRR is a cash reserve ratio which every bank required to maintain into cash
as deposit with RBI whereas in SLR is a statutory liquidity ratio, which every bank
have to maintain in form of gold or cash or unencumbered approved securities as per
their demand and time liabilities.
Objective: The objective behind CRR is to control inflation and smooth the money
supply in country whereas SLRs objective is to restrict the expansion of bank credit,
to boost the investment of the banks in government securities and to ensure solvency
of banks.
Maintenance: CRR should maintain after every 14 days with RBI whereas SLR, it
should be maintained at the end of the day.


CRR emphases on controlling liquidity in banking sector whereas SLR emphases on
the credit growth of a country.

IMPACT OF CRR AND SLR

The commercial banks are required to maintain a certain percentage of deposits as reserves
with RBI. RBI is legally authorised to raise or lower the minimum reserves that the banks
must maintain against the total deposit. If the percentage of reserves to be maintained is
increased, the CBs will be left with less cash and therefore, they have to contact credit and if
the limit is reduced, the CBs will have more cash with them and they would be able to
expand credit.(reserve bank of India and its role, tannans banking). The impact of CRR and
SLR on Indian economy can be understood under following headings:

1. Impact on interest rate: If there is an increase in the percentage of CRR then it
will make the amount which is available with the bank to come down. RBI uses this
method to drain excessive money from the banks. If the CRR increases then the bank
have to keep additional amount with RBI and if the bank keeps more with RBI then
they can offer less at high rate of interest to them. Hence, RBI increases CRR to drain
out excess money and vice versa.

2. Impact on investment from organisation prospective: Organizations
present in economy requires money for the development and for various other
purposes. Increase in interest which occurred due to increase in CRR may result into
less amount available for these organizations. Due to this, growth of the economy
slows down.



3. Impact on common public: In todays time public is very dependent upon the
banks as it provides the loan facility availing some services. Increase in CRR which
result into high interest rates make the public consume less. Increase in CRR and SLR
may lead to higher returns from debt oriented instruments due to high interest rates and
Loans would become costly as the banks would charge a higher rate of interest. If the
loan taken by borrower is at fixed interest rate then he would be immune to any rise in
interest rate but if he has a floating interest then either the term of the loan or EMI
would increase. A reduction in SLR makes the borrowers pay less on their loans as the
rate of interest will be cheaper and vice versa.

4. Impact on Exports and Imports: If interest rates are high, firms will consume
less amount and produce less goods and services which may reduce their expansion
plans. Since the production has decreased, this will lead the people to purchase their
desired products from foreign markets. Due to this, imports will increase and exports
decreases, ultimately put downward pressure on GDP.
5. Impact on Inflation: Inflation takes place when there is an increase in demand
and reduction in supply. Inflation can be reduced, by either reducing the demand or
increasing the supply. If CRR increases, banks have fewer funds to lend; this will
make the borrowing costly, and reduces demand. Moreover, companies have to bear
the losses as booking of high interests costs on their Profit & Loss statements may
reduce profits and this may lead to reduction of demand. On the other hand, reduction
in CRR has adverse effect. It increases demand. To tackle this problem the government
have to increase the supply i.e. to meet with the demands, for this government has to
take few steps to cut indirect trade barrier. Whereas in SLR a slight decrease will not
adversely affect the inflation but it will helps in increasing the liquidity in the market.



Increase Banks have to maintain customers borrow demand
In CRR less money profit margin less and eventually for goods
For lending banks increases spend less and services
Lending rates thus comes down

6. Impact on fixed deposits: when RBI increases CRR, it requires the bank to keep
reserves. Thus, the banks would have less funds to generate income. It will
affect the bank income and to deal with this problem, the banks reduce the deposit
rates.
7. Impact on exchange rate: Increasing interest rates tends to increase the foreign
capital investment. India is in a transition stage, wherein its progressively becoming
an open economy from a closed one. The complexities thus increase, because of the
linkages between exchange rate movements and interest rates and the impact of
increasing capital flows across the border. The CRR hike and changes to the reverse
repo mechanism are not expected to have a direct impact on the exchange rate in the
near term. A cut in reserve requirements would raise the level of liquidity in the
system. This will lead to a decrease in inflow of foreign money that is coming into
India for interest rate arbitrage and thus would stem the rupee rise higher.

CONCLUSION:
RBI is considered as one of the best regulators of financial system all over the world. This is
because its monetary policies prescribe strict rules and regulations for maintenance
of statutory reserves ratios. CRR and SLR perform similar objectives but plays different role
in different manner. CRR aims at maintaining a portion of banks liquidity with the Central


Bank whereas SLR concentrates on the same purpose but in different manner i.e. by asking
the banks to maintain a portion of their liquid assets with themselves. The impact it creates on
the Indian economy proves to be beneficial as these restrictions helped the Indian economy to
sail through the global financial crisis when other big players like Lehman Brothers could not
survive these crises. CRR helps in adjusting the liquidity in the system and makes the money
supply smoother in the economy. If there is excess money supply in the market, CRR is
increased by the RBI to drain out the excess. If the economy falls short of liquidity, then RBI
will take the step of decreasing the CRR to release more funds in the market. Therefore, RBI
uses this instrument to control inflation. CRR is one of the factors that influence interest
rates. If there is any reduction in the SLR that indicates that the home, car and commercial
loan rates will go down or if there is an increase then it will restrict the banks leverage
position to pump more money into the economy. If the percentage of reserves to be
maintained is increased, the CBs will be left with less cash and therefore, they have to contact
credit and if the limit is reduced, the CBs will have more cash with them and they would be
able to expand credit. Whether there is a hike or cut in the reserve ratios, it will have its
impacts on the abovementioned fields. Thus, a lower capital ratio requirement will be helpful
in maintaining the liquidity in the market which would later act as a contributing factor in the
development of the economy but if we try to look at another side i.e. increase in CRR it not
always have the negativity but sometime present itself as positive and helpful instrument. If
CRR increases it will boosts up interest rate also as well as plays an important role in pulling
down the inflation to some extent as we already have discussed above how it is done under
the heading inflation.

You might also like