Introduction
The Central Bank (like the Reserve Bank of India – RBI) uses various tools to control the flow of money in the economy. Two of the most important tools are:
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Cash Reserve Ratio (CRR)
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Statutory Liquidity Ratio (SLR)
These tools help maintain financial stability, control inflation, and regulate the credit available in the economy. Let’s explore these concepts in detail with examples.
1. Cash Reserve Ratio (CRR)
Definition
Cash Reserve Ratio (CRR) is the percentage of a bank’s total deposits that it must keep with the central bank (RBI) as a reserve. This reserve is maintained in cash and cannot be used for lending or investment.
Purpose of CRR
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Controls money supply: Helps the central bank regulate the amount of money available for lending.
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Manages inflation: If inflation is high, the RBI increases CRR to reduce excess liquidity in the system.
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Ensures liquidity: Ensures that banks have enough reserves to meet their obligations.
How CRR Works?
Let’s assume:
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A bank receives ₹1000 crores in customer deposits.
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The CRR is 5%.
This means the bank must keep ₹50 crores (₹1000 crores × 5%) with the RBI. The remaining ₹950 crores can be used for lending or investment.
Impact of CRR Changes
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If CRR Increases
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Banks must keep more money with the RBI.
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Less money is available for lending.
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Interest rates may increase.
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Helps control inflation by reducing excess liquidity.
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If CRR Decreases
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Banks can keep less money with the RBI.
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More money is available for lending.
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Interest rates may decrease.
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Helps stimulate economic growth by increasing liquidity.
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Analogy
Think of CRR like a mandatory piggy bank that every bank must maintain with the RBI. The central bank can increase or decrease the size of this piggy bank to regulate the money available in the economy.
2. Statutory Liquidity Ratio (SLR)
Definition
Statutory Liquidity Ratio (SLR) is the percentage of a bank’s total deposits that it must maintain in liquid assets such as cash, gold, or government-approved securities (like bonds). Unlike CRR, these funds stay with the bank but cannot be used for lending.
Purpose of SLR
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Ensures liquidity: Makes sure banks always have liquid assets to meet withdrawal demands.
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Strengthens financial stability: Encourages banks to invest in government securities.
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Controls inflation and credit growth: A higher SLR reduces lending ability, controlling inflation.
How SLR Works?
Let’s assume:
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A bank receives ₹1000 crores in customer deposits.
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The SLR is 20%.
This means the bank must keep ₹200 crores (₹1000 crores × 20%) in the form of cash, gold, or government securities. The remaining ₹800 crores can be used for lending.
Impact of SLR Changes
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If SLR Increases
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Banks must invest more in government securities or keep more cash.
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Less money is available for lending.
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Helps in controlling inflation and maintaining financial discipline.
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If SLR Decreases
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Banks have more money to lend.
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Encourages credit growth and economic expansion.
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Analogy
SLR is like an emergency fund that banks must maintain. It ensures that banks always have a backup to meet sudden customer withdrawal demands.
Key Differences Between CRR and SLR
| Feature | CRR (Cash Reserve Ratio) | SLR (Statutory Liquidity Ratio) |
|---|---|---|
| Where is the money kept? | With the RBI | With the bank itself (in cash, gold, or securities) |
| Purpose | Control liquidity and inflation | Ensure financial stability and liquidity |
| Impact on lending | Directly affects how much banks can lend | Limits the funds banks have available for lending |
| Flexibility | Less flexible, as funds are locked with RBI | More flexible, as funds remain with the bank |
Conclusion
Both CRR and SLR are powerful tools used by the Reserve Bank of India (RBI) to regulate the economy. While CRR controls the amount of money banks can lend, SLR ensures that banks maintain financial stability by holding safe and liquid assets.
Understanding these concepts is crucial for anyone interested in banking, economics, or financial regulations. These measures help strike a balance between economic growth, inflation control, and financial security.
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