A crucial sector of any economy is its banking sector. It often serves as a mirror to the overall economy, with banking activity enabling investment decisions. Along with repo rate, reverse repo rate, etc., Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are crucial components of banking operations. The two ratios help determine the liquidity in the banking system and indicate national inflation and growth fluctuations. 

Cash Reserve Ratio (CRR)

Cash Reserve Ratio (CRR) refers to the percentage of a commercial bank’s total deposit that it must maintain in the form of cash with the central bank. CRR in India is set by the Reserve Bank of India (RBI) under the powers conferred to it by the RBI Act of 1934. It is a crucial tool used by the RBI to regulate the percentage of money circulating in the economy. When the CRR is high, banks have less money to lend, which can help control inflation. Conversely, a lower CRR means banks have more money to lend, which can stimulate economic growth. 

Advantages of CRR

1. By adjusting the CRR, the RBI can control the amount of money that banks have available to lend, which can help control inflation.
2. It ensures that banks have a certain amount of cash in hand, promoting financial stability and reducing the risk of bank failure.
3. CRR is a powerful tool for regulating the supply of money in the economy, which can influence interest rates and economic growth.

Disadvantages of CRR

1. A high CRR can limit the amount of money available to the banks for lending purposes, which can, in turn, slow down economic growth.
2. Money that is held as part of the CRR does not earn interest, which can reduce bank profits.
3. If the CRR is too high, it can cause liquidity problems for banks, especially during times of financial stress.

Rules for Setting CRR in India

The RBI reviews the CRR as part of its monetary policy review, which typically occurs bi-monthly. Regulation of CRR acts as a tool to increase and decrease money supply in the economy.The RBI uses the CRR as a tool to control the liquidity in the Indian economy. Here are the key rules for setting the CRR in India:

• The RBI may set CRR between 3% and 15% of a bank''s Net Demand and Time Liabilities (NDTL). However, currently, there is no specified lower or upper limit for the CRR.
• It is maintained in cash and cash equivalentsand must be stored in the bank’s vault or held as balances with the RBI.
• The CRR is required to be calculated based on the bank’s NDTL as of the last Friday of the second preceding fortnight. The required reserves are average daily balances that a bank must maintain over a two-week period.
• Banks cannot earn any interest on the funds held as part of the CRR.
• In case, the bank fails to maintain the required CRR, the RBI can impose a penalty.

Statutory Liquidity Ratio (SLR)

The Statutory Liquidity Ratio regulates the flow of money in the economy. It is the percentage of a bank’s net time and demand liabilities that must be maintained as cash, gold, and approved securities. The primary purpose of the SLR is to ensure that banks have enough funds to meet their obligations to their customers. As of 2024, the current SLR is 18.00%.  

The SLR indirectly affects the lending capacity of the banks. A higher SLR means banks have less money available for commercial lending. A low Statutory Liquidity Ratio indicates that banks have more funds available for public lending or investment in other profitable avenues. In case many depositors demand back their money at the same time, the bank might struggle to meet these demands due to the lower level of liquid assets.

Rules for Setting SLR in India

The rules for setting the Statutory Liquidity Ratio (SLR) in India are governed by the Reserve Bank of India (RBI). The RBI, under Section 24 of the Banking Regulation Act, 1949, has the authority to set the SLR rate. Here are the key rules:

1. The RBI determines the SLR rate, and it is reviewed periodically. This can be changed as per the economic conditions and the objectives of the monetary policy.
2. As per the Banking Regulation Act, every bank in India is required to maintain the minimum proportion of Net Demand and Time Liabilities (NDTL) as liquid assets, such as cash and gold, at the close of business every day.
3. Liquid assets may be available as cash, gold, or approved securities. The value of such assets is calculated as a percentage of the total demand and time liabilities.
4. If a bank fails to maintain the required SLR, it is liable to pay a penalty to the RBI. The penalty can be imposed as a higher interest rate on the shortfall amount or a monetary fine.
5. Banks are required to report their SLR position to the RBI. This helps the RBI to monitor compliance and take necessary action in case of any shortfall.

Advantages of SLR

Banks maintain SLR due to the following advantages:

1. The SLR ensures that banks have a certain level of liquid assets that they can use to meet customer withdrawals or other obligations.
2. By requiring banks to hold a certain percentage of their liabilitiesin liquid assets, the SLR promotes financial stability and reduces the risk of bank failure.
3. The SLR can be used to control credit growth in the economy. When the SLR is high, banks have less money to lend, which can help control inflation.

Disadvantages of SLR

1. Limits Lending: A high SLR can limit the amount of money that banks have available for the purpose of lending, which can slow economic growth.
2. Reduces Bank Profits: Assets that are held as part of the SLR often earn lower returns than other investments, which can reduce bank profits.
3. Can Cause Liquidity Problems: If the SLR is too high, it can cause liquidity problems for banks, especially during times of financial stress.

Similarities Between CRR and SLR

The following points indicate similarities between CRR and SLR:

• CRR and SLR are regulatory measures used by the RBI to manage liquidity in the economy. This ensures the stability and solvency of the banking
• Both ratios directly impact the banking sector as they determine the amount of funds that banks have to keep aside either as cash (CRR) or in the form of liquid assets (SLR).
• CRR and SLR influence the money supply in the economy. A higher CRR or SLR reduces the money banks can lend out, thereby contracting the money supply. Conversely, a lower CRR or SLR increases the money supply by allowing banks to lend more.
• Compliance with both CRR and SLR is mandatory for all scheduled commercial banks in India. Non-compliance can result in penalties imposed by the RBI.
• Banks are not allowed to use either the cash kept aside for CRR or the assets kept aside for SLR to earn interest or profit.
• Both CRR and SLR act as safety measures, ensuring that banks have enough reserves to meet any unexpected large-scale withdrawals by depositors.