Do you know What is Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR)? If you are from the banking background or have keen interest in it, you might already be aware of it. If not, don’t worry we shall clarify your doubts on these two important and useful banking terminologies.
Banking in India: An Overview
A banking institution is the backbone of any economy. It lays the financial pillars of the country and establishes the country in the global market. India has a number of nationalised banks which operate and regulate the Indian financial market. Don’t mind me saying, but Reserve bank of India (RBI) is the king of banks. RBI is India’s central banking institution.
This organization controls the issuance and supply of the Indian rupee currency and many related monetary policies. RBI is also responsible for framing and managing bank regulation and policies. Talking about banking regulation, let’s talk about the two most crucial ratios in the banking regulations: Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR).
What is CRR or Cash Reserve Ratio? Meaning
As per section 42 of the RBI Act, 1934 every bank is to keep a minimum balance percentage or amount with RBI. This minimum amount percentage is called “Cash Reserve Ratio (CRR)”. CRR enables a bank to know the amount available with them for further investment and dealing. This rate majorly regulates the cash flow in a country and is used to channel out any excessive money from the system.
The CRR rate normally ranges in between 3 to 20%. For 2019, the current ongoing CRR rate is 4%.
If banks do not comply with the CRR guidelines as required on a daily basis: they are charged with interest penalty @3% per annum over and above the applicable bank rate. If such a deficit continues on the subsequent day(s), then the interest penalty will be @ 5 % per annum over and above the applicable bank rate.
What is SLR or Statutory liquidity ratio? Meaning
Statutory liquidity ratio (SLR) is the amount of liquid cash which every bank needs to keep at the end of each business day. In business or technical language, SLR is Indian government term for the reserve requirement that the commercial banks in India is required to maintain in the form of cash, gold reserves or allowed securities. This reserve which mostly is over and above CRR can be used to help depositor in case of demand for money increased.
RBI can extend the SLR rate up to 40% of the total contribution. But, the current rate for SLR in 2019 is 19.25% only.
Statutory liquidity ratio or SLR Formula
SLR = (Liquid assets / (Demand + Time liabilities)) × 100%
Penalty for not complying with CRR and SLR
If a bank does not comply with the CRR and/or guidelines as required on a daily basis, the banks are charged with interest penalty @3% per annum over and above the applicable bank rate. If such a deficit continues on a subsequent day(s), then the interest penalty will be @ 5 % per annum over and above the applicable bank rate.
How does CRR and SLR work and how it affects us?
The money flow in a country is determined and defined by the monetary policy of that company. As we know, RBI is a key player in monetary reforms and policies in India. RBI devises the policy to control and manage cash flows in the market available to the Indian public. In deriving such policies, CRR and SLR play a very critical role.
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How CRR & SLR impact our economy?
CRR is a reserve ratio, the actual minimum cash balance to be kept by each bank in India. While SLR is the liquidity ratio which means it’s the actual liquid value with the bank which a bank has it for investment and funding. Thus, the higher the CRR and SLR rate is, the lower is the liquidity with the bank and vice versa.
Let me explain this through a hypothetical example:
When the RBI wants or needs to increase the funds into the economy, it lowers CRR which means the bank has more funds to utilize and work with. Banks have more cash and thus the interest rates are lower, which means cheap loan. The banks, in turn, extend a large number of loans to the businesses and industry for different investment purposes. This ultimately boosts the growth rate of the economy.
Also, if you look from another angle, the lower these rates are means people have more cash in their hands which means everyone has higher purchasing power. Higher the purchasing power with lower supply may lead to inflation.
Similarly, when the rate of SLR and CRR is higher, the bank has less money for their function which results in a higher interest rate which ultimately makes the cost of the loan or financial investment high. Thus, starting a new factory or buying a new house or car or bike becomes expensive. This can curb growth and lead to the slowdown of the economy. Because the cash flow is low, people tend to buy less and that in itself triggers a lower inflation rate.
Thus, there should be a balanced ratio for ensuring the economy is growing and at the same time keeping a check on inflation. The rates decided must not affect us or our finances adversely.
I can’t even imagine what statics and planning go into deciding such ratios to bring equilibrium in our economy. Undoubtedly, these are two significant ratios to manage and maintain the economic growth of the country.
CRR vs SLR: Comparison Chart
| Basis | CRR or Cash Reserve Ratio | SLR or Statutory Liquidity Ratio |
|---|---|---|
| Meaning | The money which banks keep with RBI in form of cash. | The banks keep a percentage of Net Demand & Time Liabilities (NDTL) in form of liquid assets. |
| Form | This is in cash form. | This includes cash, gold and Government securities. |
| Maintained with | CRR is maintained by banks with RBI. | The assets are kept with the bank itself. |
| Importance | Helps control the excess money flow in the market. | For ensuring solvency of banks and regulate flow of money in the economy. |
| Controls | CRR controls the liquidity in banking system. | SLR controls the bank's leverage for credit expansion. |
| Returns | Money parked in CRR doesn't earn any returns. | Banks earn returns on money parked as SLR. |
Let’s have an in-depth look at the differences between CRR and SLR.
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CRR vs SLR: Differences to Know
Although, both the ratios are used for controlling the money movement in a country and ultimately work through the improvement or downfall of an economy, there are some differences among them.
The differences between CRR and SLR are as below:
1. What is the ratio reserve of?
Both are reserve ratios, but CRR is the actual cash reserve to be maintained in cash alone. Whereas SLR is the liquid ratio which comprises of cash, gold or allowed securities reserves.
2. Who maintains the balance?
In the case of SLR, the reserve amounts are kept with the banks themselves i.e. this reserve is calculated and maintained by the bank. Whereas cash reserve is maintained by the banks with RBI i.e. the amount is deposited at RBI.
3. What is the rate of return?
As the amount is kept within the bank, banks earn returns on money reserved and maintained under SLR. The amount under CRR is deposited and maintained by RBI and thus there is no interest disbursement on money maintained as CRR.
4. What is the impact of the reserve ratio on our economy?
SLR is used to control the bank’s power for credit expansion (i.e. helps in cases where there is an increment in monetary demand) whereas CRR affects the actual liquidity (i.e. controls cash flow) of the funds in the economy.
A CRR and SLR rate definitely form the base for many financial and economic calculations like inflation rate, Gross Domestic Product (GDP) indicator and economic growth for any country. Thus, it would not be wrong in me saying, that CRR and SLR rates are epi-center of any monetary policy making.
Now, that you have learnt about CRR and SLR, you can surely crack one of the commonly asked banking interview questions. Can you guess what’s it? Of course, explain the difference between CRR and SLR. And, you are ready to answer that.