Reserve Bank of India plays the role of the central bank in India with the authority to issue currency notes. The prime function of RBI involves monitoring and controlling the supply of money across the economy and the cost of credit. While the supply of money refers to the amount of money available for the economy, the cost of credit refers to the price at which the economy can borrow the available money.

The supply of money and the cost of credit have a significant impact on growth and inflation in the economy. To control growth and inflation, certain tools are used by RBI. The different control tools include Repo Rate, Reverse Repo Rate, Cash Reserve Ratio, and Statutory Reserve Ratio.

What Is Cash Reserve Ratio (CRR)?

Cash Reserve Ratio refers to the percentage of the deposit that the commercial banks have to keep with the RBI. Under the criteria of CRR, a certain ratio of the total bank deposits has to be kept in the RBI’s current account. CRR is a popular instrument that the central bank uses to control the system’s liquidity. The commercial banks neither have access to the deposited amount, nor do they earn any interest on the deposited amount. The current CRR of RBI is 4%, according to the latest updates of October 2019.

Aim of Cash Reserve Ratio

Cash Reserve Ratio pretends to be one of the citation rates when the base rate is determined. The base rate can be defined as a minimum loaning amount up to which a bank would not be allowed to provide funds. The rates are prescribed by India’s leading bank, the Reserve Bank of India and it ensures lucidity when it comes to the give-and-take transactions in the credit markets. Two of the important aims when it comes to the Cash Reserve Ratio would be,

• Cash Reserve Ratio guarantees that the deposit amount is taken care of by the Central Bank, which is why the transaction is a secure one.
• Another important objective with respect to the CRR would be inflation rates, which are kept under the standard benchmark. If the inflation percentage raises above the standard amount, RBI would just increase the Cash Reserve Ratio. This would cause the banks to provide a lower level of loan amounts.

Thus, the aim of maintaining the CRR is to balance out the things with respect to the depositors and the creditors.

How Does Cash Reserve Ratio Work?

The way in which the CRR works is all up to the current market conditions and the inflation rates. If the inflation increases, RBI would increase the CRR and the total funds available with the banks would reduce. This is how RBI keeps a stopover with regard to excessive cash flow.Also, with respect to the Net Demand and Time Liabilities (NDTL), overall balance maintained by the banks with the RBI should be more than 4%.

NDTL is basically defined as the consolidated demand and time deposits that are held by the banks. This can also include amounts deposited by the public, and balance amounts held by different banks. Demand Deposits usually consist of all the liabilities that banks need to requite instantly, and they consist of current deposits, DD, balances remaining in fixed deposit accounts that are long behind schedule, etc.

Time Deposits are those that need to be reimbursed once the maturity level is reached disabling the depositor from withdrawing any amount instantly.

It should, therefore, be understood that an increased Cash Reserve Ratio would result in lower amounts available with the banks which would otherwise be used for investment or loan purposes.

How does Cash Reserve Ratio affect the Country’s economy?

When it comes to the monetary policies of RBI, CRR is at the topmost level as one of the primary components of this. CRR essentially regulates the country’s money supply, inflation levels and also liquidity. If the CRR is high, liquidity would be lower, and it would work in the opposite way, therefore.

When inflation rates are high, cash flow is mainly reduced to balance out the economic conditions. This is the reason the CRR rates are spiked up by RBI decreasing the loan amounts lent by the banks. This would again decrease the total Rate of Investment and money supply would cease temporarily. This can cause the economy to fluctuate but it helps with bringing the inflation rates down which is better in the long run.

When the economy is stable and RBI needs to increase the cash flow, the Cash Reserve Ratio would then be decreased. Total lending funds for the banks would increase as well thereby increasing the total money supply. This again affects the economy immensely in a positive way.

Part of Cash Reserve Ratio

Statutory Liquidity Ratio is essentially a part of the Cash Reserve Ratio, and both of them are governed and controlled by the Reserve Bank of India. CRR mainly requires banks should only have cash reserves with the RBI whereas SLR involves that banks are requested to store such assets.

Since RBI is the primary credit controller when it comes to the country’s cash flow, many points come into the fore which is why both CRR and SLR are very crucial. The Central Bank mainly controls the overall liquidity with respect to the banking system whereas SLR would be used to leverage the banks enabling the expansion of credit rates.

Since RBI is the chief kingmaker, cash reserves maintained with them would constitute the CRR. Whereas the banks that come under them would come under the ambit of SLR. This is why it is true when we say that SLR is a part of CRR.

What Is Statutory Liquidity Ratio (SLR)?

Statutory Liquid Ratio refers to the percentage of bank funds that the commercial banks have to maintain as liquid assets at any point in time. It is the percentage of the deposit that the banks invest in financial securities like the state government securities or central government securities. The current statutory liquidity ratio, as per October 2019, is 19.5%. The RBI CRR and SLR have a significant influence on the extent to which the banks can lend money to the home buyers.

Aim of Statutory Liquidity Ratio

Statutory Liquidity Ratio is a terminology that is synonymous with stockpiling requirements that are maintained by multiple commercial banks. These can be in the form of cash or gold funds or securities expressly approved by RBI. This would, in turn, provide much-needed credit to the users.

The two main aims with respect to the Statutory Liquidity Ratio are,

• The main aim is to decrease the over-liquidity that might occur with commercial banks. This could happen because SLR is missing in this case, and the bank requires funds for the same. RBI, therefore, employs the use of SLR so that bank credit would be controlled by them.
• RBI also increases the Statutory Liquidity Ratio when the economy is hit with inflation. This keeps the bank credit in control, lessens up the SLR and releases additional pressure that might otherwise prove cumbersome to the banks.

How does Statutory Liquidity Ratio Work?

As mentioned above, the Statutory Liquidity Ratio is mainly contained of cash and gold reserves, and other liquid assets. This is why banks need to have such assets which would then become a part of the Net Demand and Time Liabilities (NDTL). The ratio of all these assets with respect to the NDTL forms the SLR.

SLR is mainly defined in terms of percentage and is utilized to control the inflation rates and growth in fuel as well by controlling the cash flow. Government Security holdings with the Indian banks are now very much in close proximity to the statutory minimum amount that needs to be complied with. This is why SLR is important.

RBI would have the sole authority to increase the SLR by up to 40%. Any more increase than this would hamper the banks to pump in more money. SLR is a very vital policy written down by the RBI that is a key factor when it comes to securing the solvency of the commercial banks.

SLR Impact on the Investor

It is important to know that the Statutory Liquidity Ratio is one of the key reference points that RBI even references so that the base rate would be set. The base rate is mainly defined as the loaning amount as we have mentioned above. It is important that banks would stay on the Base Rate and not overshoot. SLR rates are fixed by the RBI therefore so that transactions in the credit market happen smoothly. Base Rate is also very instrumental in cutting down the loaning amounts so that banks would be able to provide you loans with inexpensive rates.

Whenever the Reserve Bank of India urges a reserve requirement, a small portion of your liquid assets would be kept safely. This would be available to the consumers for redeeming them as and when they want to. But there is a flip side to this rule, which is that it would lower the loaning volume of the bank immensely. This is why rates would need to be increased for allowing increased cash flow.

Difference between Statutory Liquidity Ratio & Cash Reserve Ratio

What Is Base Rate?

The base rate refers to the lowest possible rate of interest that can be charged by the banks from its customers. The management of the commercial banks holds the right to decide as well as change the base rates. Even though the central bank does not control the base rate directly, but it can influence it using the Repo rate and other control instruments. For instance, when the central bank lowers the repo rate, the commercial banks can lower the base rate and provide benefits to the customers.

What is Repo Rate?

Usually, when there is a need for money, one of the popular options is availing a loan from the bank. The banks lend the required money and charge a certain amount of interest rate, which is referred to as the cost of credit. When the banks need money in case of fund shortage, they approach the RBI, who lends them money at the Repo rate.

Repo Rate is the interest rate at which the commercial banks can borrow money from the RBI. By selling the surplus government securities to the central bank, the commercial banks can avail the required money at the Repo rate to meet their daily obligations.

How Does Repo Rate Work?

When the commercial banks are in a deficit of money, they can count on the RBI for help. The RBI can lend the money by charging an interest rate on the principal amount. The interest rate charged is known as the repo rate. Repo refers to ‘Repurchasing Option.’ Repo is a type of contract in which the commercial banks provide valid government securities to the central bank to avail of the loan. The agreement also includes a predetermined value to repurchase the securities in the future.

What are the Components of a Repo Transaction? 

The different components of a repo transaction between the central bank and the commercial banks include:

1. The valid government securities provided by the banks as collateral to RBI.
2. The loan amount that RBI lends to commercial banks.
3. The interest rate or the repo rate that is charged by RBI on the given amount.
4. The repayment of the loan amount by the commercial banks to RBI and the repurchase of the securities from RBI that was given in the form of collateral.

How Does the Repo Rate affect the Country’s Economy?

Repo rate acts as a powerful tool that is used by RBI to regulate the money supply, liquidity, and inflation levels of the country. The repo rate is directly proportional to the cost of borrowing for commercial banks. Higher the repo rate, the higher will be the borrowing cost and vice versa.

When there is a rise in inflation, RBI increases the repo rate to bring down the money flow in the economy. An increased repo rate makes borrowing costly, thereby slowing down the investments and reducing the money flow in the economy. Though it brings down inflation, increased repo rate leads to decreased growth of the economy.

On the other hand, when RBI wants to enhance the cash flow into the economy, it reduces the repo rate and increases the supply of money, which in turn boosts economic growth.

Current Repo Rate and its Impact

The recent repo rate of RBI, according to the updates of October 2019, is 5.15%. The change in the repo rate impacts all the different sectors of the economy. Certain segments may experience profit, while others may have to suffer loss. The change in the repo rate causes the banks and financial institutions to change their lending rates for the customers.

What Is Reverse Repo Rate?

Reverse repo rate refers to the interest rate that is offered by RBI to the commercial banks when they deposit their surplus funds with the central bank for shorter periods. When the commercial banks have surplus money but lack investment or lending options, they choose to deposit the additional fund with RBI and earn interests. It is also referred to as the interest rate at which RBI borrows money from commercial banks. The RBI reverse repo rate as of October 2019 is 4.9%.

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