Have you ever wondered what it takes for banks to maintain a stable financial system? Well, there are two crucial tools that play a significant role in keeping the economy running smoothly: Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
CRR (Cash Reserve Ratio) is the percentage of total deposits that banks must keep with the central bank as reserves, ensuring liquidity and stability in the banking system. While SLR (Statutory Liquidity Ratio) is the percentage of total deposits that banks must maintain in the form of liquid assets like cash, gold, or government securities, providing a cushion against liquidity risks and promoting financial stability.
CRR vs. SLR
|CRR (Cash Reserve Ratio)||SLR (Statutory Liquidity Ratio)|
|CRR is the percentage of a bank’s total deposits that it must hold as reserves in the form of cash with the central bank, such as the Reserve Bank of India (RBI).||SLR is the percentage of a bank’s total deposits that it must maintain as liquid assets, including cash, gold, or approved securities, as mandated by the central bank.|
|It is primarily used as a monetary policy tool by the central bank to regulate the liquidity in the banking system, influence lending capacity, and control inflationary pressures.||It serves as a prudential measure to ensure the liquidity and solvency of banks, providing a cushion against liquidity risks and promoting stability in the financial system.|
|CRR applies only to a bank’s demand and time deposits and is maintained in the form of cash reserves with the central bank, offering immediate availability to meet withdrawal demands.||SLR includes a broader range of assets, such as cash, gold, and approved securities like government bonds, which provide more diverse options for maintaining liquid reserves.|
|It is determined and regulated by the central bank, which sets the specific percentage that banks must maintain as reserves, and can be adjusted as part of the monetary policy framework.||It is also set and regulated by the central bank, which defines the minimum percentage of deposits to be held as liquid assets, with the aim of ensuring financial stability.|
|CRR directly affects a bank’s liquidity by reducing the amount available for lending, potentially impacting profitability, while also influencing interest rates and overall monetary conditions.||SLR affects a bank’s investment decisions, as it requires a portion of deposits to be held in approved liquid assets, which can limit the available funds for other investment opportunities.|
|It provides the central bank with more immediate control over the liquidity in the banking system, as adjustments to the CRR can be made relatively quickly to address changing economic conditions.||It offers a more stable and long-term liquidity requirement, with changes in the SLR typically implemented gradually to allow banks time to adjust their holdings of liquid assets.|
What is CRR?
CRR, or the Cash Reserve Ratio, is the percentage of a bank’s deposits that it must keep with the RBI at all times. The remaining portion can be lent out to customers or invested in government securities.
The CRR is set by the RBI and currently stands at 4%. This means that for every Rs. 100 that a bank has in deposits, it can lend out or invest Rs. 96.
The main purpose of the CRR is to ensure that banks have enough cash on hand to meet customer withdrawals and other obligations. It also helps to regulate the amount of money in circulation and prevent inflation.
When the RBI wants to tighten the money supply, it increases the CRR rate which effectively reduces the amount of money available for banks to lend out. This consequently leads to higher interest rates and slower economic growth.
What is SLR?
The term “SLR” stands for “statutory liquidity ratio.” The statutory liquidity ratio is the percentage of a bank’s total deposits that the bank must keep in reserve at the close of business each day. The reserve requirements are set by the country’s central bank. In India, for example, the Reserve Bank of India (RBI) sets the SLR at 18%. That means that for every Rs.100 of deposits a bank has on hand, it must set aside Rs.18 in reserves.
The purpose of the statutory liquidity ratio is to ensure that banks have enough liquid assets on hand to meet their obligations on any given day. The ratio also helps to control inflation by keeping extra money out of circulation. When commercial banks have to set aside a larger portion of their deposits as reserves, they have less money available to lend out, which can help to slow the growth of the money supply and prevent inflationary pressures.
Similarities between CRR and SLR
- Both CRR and SLR are regulatory requirements imposed by the central bank on commercial banks.
- They are designed to manage liquidity within the banking system.
- Both ratios mitigate risks by ensuring banks hold reserves or liquid assets.
- The central bank has control over changes in CRR and SLR as part of monetary policy.
- They serve as prudential measures to promote financial stability.
- Banks must comply with CRR and SLR guidelines and report their reserve positions regularly.
How they affect the economy
The CRR is the percentage of a bank’s deposits that it must keep as cash reserves with the RBI. The RBI uses the CRR to control inflation and ensure that there is enough cash in the system to meet demand. When the RBI increases the CRR, it becomes more expensive for banks to lend money, which slows down economic growth. Conversely, when the RBI decreases the CRR, it becomes cheaper for banks to lend money, which can help spur economic growth.
The SLR is the percentage of a bank’s deposits that it must keep as liquid assets, such as cash or government securities. The purpose of the SLR is to ensure that banks have enough liquidity to meet demands for withdrawals and other obligations. Unlike the CRR, changes in the SLR do not directly affect lending rates or economic growth. However, if the RBI were to suddenly increase the SLR, it could cause a shortage of liquidity in the banking system, leading to higher lending rates and slower economic growth.
Practical examples of CRR and SLR
The RBI uses the CRR and SLR requirements as tools to control liquidity in the banking system and manage inflation. An increase in either ratio leads to a decrease in the amount of money available for lending, which has a contractionary effect on the economy. A reduction in either ratio has an expansionary effect on the economy by freeing up more funds for lending.
In practical terms, let’s say a bank has Rs.1,000 crore on its books. Of this, it needs to maintain Rs.40 crore as CRR and Rs.215 crore as SLR, leaving it with Rs.745 crore available for lending or investment purposes. If the RBI increases the CRR to 5%, the same bank would need to set aside Rs.50 crore as CRR, leaving only Rs.700 crore available for lending or investment purposes – a contractionary move by the RBI that would lead to less credit being extended by banks and ultimately slower economic growth.”
Key differences between CRR and SLR
- Purpose: CRR is primarily aimed at maintaining cash reserves with the central bank to meet depositor demands and ensure stability in the banking system. SLR, on the other hand, requires banks to maintain a certain percentage of their deposits in the form of liquid assets like cash, gold, or government securities to meet liquidity requirements.
- Nature of Assets: CRR requires banks to maintain a portion of their deposits in cash form only. In contrast, SLR allows banks to hold a broader range of liquid assets, including cash, gold, and government securities.
- Calculation Method: CRR is calculated as a percentage of a bank’s net demand and time liabilities (NDTL). SLR, on the other hand, is calculated as a percentage of a bank’s total demand and time liabilities (TDTL).
- Difference between Loan and Advance
- Difference between Direct Debit and Standing Order
- Difference between Current and Capital Accounts
CRR focuses on maintaining cash reserves with the central bank, while SLR requires banks to hold a certain percentage of their deposits in liquid assets. CRR has a more direct impact on lending capacity, while SLR promotes financial stability and provides a buffer against liquidity risks. Understanding these key differences helps banks and policymakers effectively manage liquidity, maintain compliance, and promote a stable banking environment.