One of the core sectors of the economy is the Banking Sector. In fact, it mirrors the underlying trend of the economy, which plays a crucial role in the financial markets. Savvy investors usually rely on crucial details coming out of the banking activity before taking an investment decision. We have already touched upon certain key areas of the banking sector.
Interest rate, the repo rate, reverse repo, marginal standing facility, are some of the segments that we have discussed earlier.
Another key component of banking operations is the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). They are key determinants of the banks and the entire banking system’s liquidity condition. Let’s understand how.
Most importantly, the fluctuations in the inflation and growth of the country depend on these two ratios. CRR and SLR are the primary tools in the economy, which reduces the bank’s lending capacity and manages the money flow in the market.
Cash Reserve Ratio, or popularly known as CRR is a compulsory reserve that must be maintained with the Reserve Bank of India. Every bank is required to maintain a specific percentage of their net demand and time liabilities as cash balance with the RBI.
CRR is the percentage of total deposits, which a commercial bank has to keep as reserves in the form of cash with the RBI. The banks are not allowed to use that money, kept with RBI, for economic and commercial purposes. It is a tool used by the apex bank to regulate the liquidity in the economy and control the flow of money in the country.
Therefore, if the RBI wants to increase the money supply in the economy, it will reduce the rate of CRR while, if RBI seeks to decrease the money supply in the market then it will increase the rate of CRR.
On the other hand, Statutory Liquidity Ratio, shortly called as SLR also an obligatory reserve to be kept by the banks, as prescribed securities, based on a certain percentage of net demand and time liabilities.
SLR is a percentage of Net Time and Demand Liabilities kept by the bank in the form of liquid assets. It is used to maintain the stability of banks by limiting the credit facility offered to its customers. The banks hold more than the required SLR and the purpose of maintaining the SLR is to hold a certain amount of money in the form of liquid assets, so as to fulfill the demand of the depositors when arises.
Here, Time Liabilities mean the amount of money which is made payable to the customer after a period of time while the demand liabilities means the amount of money which is made payable to the customer at the time when it is demanded.
Let us understand the key difference between CRR and SLR.
CRR is the percentage of money, which a bank has to keep with RBI in the form of cash. On the other hand, SLR is the proportion of liquid assets to time and demand liabilities.
The next difference between these two is that CRR is maintained in the form of cash while the SLR is to be maintained in the form of gold, cash, and government-approved securities.
CRR regulates the flow of money in the economy whereas SLR ensures the solvency of the banks.
CRR is maintained by RBI, but RBI does not maintain SLR.
The liquidity of the country is regulated by CRR while SLR governs the credit growth of the country.
The RBI is required to keep the supply of money in the economy and for this purpose, it uses tools, like Bank Rate, Repo Rate, Reverse Repo Rate, CRR, and SLR.
CRR and SLR are the form of reserves, in which the money is blocked in the economy and is not used for further lending and investment purposes.
So it is clear that CRR is purely a liquid or a cash component that the banks have to maintain with RBI, under the SLR requirement apart from cash, other assets such as gold and government securities viz. Central and State government securities are required to be parked with the regulator.
Through CRR, the RBI controls excess money flow in the economy whereas the SLR requirement ensures meeting out the unexpected demand of any depositor by selling the bonds.
In short, CRR helps to regulate liquidity while SLR regulates credit growth in the economy.