CASH RESERVE RATIO AND STATUTORY LIQUIDITY RATIO

(CRR & SLR)

Subject: Financial Markets and Banking

Operations- MFS 103

Submitted to: Mr.K.V.Vikram &

Mr. S.Lakshmananan,

Professors,

Masters In Law Of Financial

Services And Capital Markets.

Submitted by: K.Samhitha,

Roll no- FS10-017,

Ist year, Ist semester,

Masters In Law Of Financial

Services And Capital Services.

NALSAR University of law Institute of Insurance &

Risk Management

Table of contents

1.Introduction

-monetary policy

-tools of monetary policy

2. CRR

-maintenance of CRR

-procedure to calculate

-exceptions to maintenance of CRR

-impact

3.SLR

-objectives

-procedure to calculate

-impact

-pros and cons of decrease in SLR

4.Conclusion

Bibliography

1.INTRODUCTION

MONETARY POLICY:

This policy determines the supply of money in the economy and the rate of interest

charged by banks. The policy also contains an economic overview and presents future

forecasts.

The Monetary and Credit Policy is the policy statement, traditionally announced twice a

year, through which the Reserve Bank of India seeks to ensure price stability for the

economy.

These factors include - money supply, interest rates and the inflation. In banking and

economic terms money supply is referred to as M3 - which indicates the level (stock) of

legal currency in the economy.

Besides, the RBI also announces norms for the banking and financial sector and the

institutions which are governed by it. These would be banks, financial institutions, non-

banking financial institutions, Nidhis and primary dealers (money markets) and dealers in

the foreign exchange (forex) market.

Initially, the Reserve Bank of India announced all its monetary measures twice a year in

the Monetary and Credit Policy. The Monetary Policy has become dynamic in nature as

RBI reserves its right to alter it from time to time, depending on the state of the economy.

The objectives are to maintain price stability and ensure adequate flow of credit to the

productive sectors of the economy. 

Stability for the national currency (after looking at prevailing economic conditions),

growth in employment and income are also looked into. The monetary policy affects the

real sector through long and variable periods while the financial markets are also

impacted through short-term implications. 

There are four main 'channels' which the RBI looks at: 

•   Quantum channel: money supply and credit (affects real output and price level through

changes in reserves money, money supply and credit aggregates). 

•   Interest rate channel. 

•   Exchange rate channel (linked to the currency).

 

•   Asset price.

TOOLS OF MONETARY POLICY:

The RBI uses the interest rate, OMO, changes in banks' CRR and primary placements of

government debt to control the money supply. OMO, primary placements and changes in

the CRR are the most popular instruments used. 

BANK RATE:

Bank rate is the minimum rate at which the central bank provides loans to the commercial

banks. It is also called the discount rate. Usually, an increase in bank rate results in

commercial banks increasing their lending rates. Changes in bank rate affect credit

creation by banks through altering the cost of credit. 

Cash Reserve Ratio 

All commercial banks are required to keep a certain amount of its deposits in cash with

RBI. This percentage is called the cash reserve ratio. The current CRR requirement is per

cent. 

Statutory Liquidity Ratio

Banks in India are required to maintain 25 per cent of their demand and time liabilities in

government securities and certain approved securities.These are collectively known as

SLR securities.

Repo 

A repurchase agreement or ready forward deal is a secured short-term (usually 15 days)

loan by one bank to another against government securities.Legally, the borrower sells the

securities to the lending bank for cash, with the stipulation that at the end of the

borrowing term, it will buy back the securities at a slightly higher price, the difference in

price representing the interest. 

Open Market Operations 

An important instrument of credit control, the Reserve Bank of India purchases and sells

securities in open market operations. In times of inflation, RBI sells securities to mop up

the excess money in the market. Similarly, to increase the supply of money, RBI

purchases securities.

Fractional reserves:

Fractional-reserves are those where only a fraction of a bank's demand deposits are kept

as reserves (cash and other highly liquid assets) available for withdrawal. The bank lends

out some or most of the deposited funds, while still allowing all deposits to be withdrawn

upon demand. Fractional reserve banking necessarily occurs when banks lend out funds

received from deposit accounts, and is practiced by all modern commercial banks.

Out of the above mentioned tools of the monetary policy, CRR and SLR are the two most

important tools which help the RBI in regulating the financial system in the country.

2.CASH RESERVE RATIO

In terms of Section 42 (1) of the Reserve Bank of India Act, 1934 the Reserve Bank

having regard to the needs of securing the monetary stability in the country, prescribes

the CRR for Scheduled Commercial Banks (SCBs) without any floor or ceiling rate.

1.1 Maintenance of CRR:

At present, effective from the fortnight beginning April 24, 2010 the CRR is prescribed at

6.00 per cent of a bank's total of demand and time liabilities adjusted for the exemptions

discuss.

1.2 Incremental CRR:

In terms of Section 42(1-A) of RBI Act, 1934, the SCBs are required to maintain, in

addition to the balances prescribed under Section 42(1) of the Act, an additional average

daily balance, the amount of which shall not be less than the rate specified by the RBI in

the notification published in the Gazette of India from time to time. Such additional

balance will be calculated with reference to the excess of the total of demand and time

liabilities (DTL) of the bank as shown in the return referred to in Section 42(2) of the

Reserve Bank of India Act, 1934 over the total of its DTL at the close of the business on

the date specified in the notification.

At present no incremental CRR is required to be maintained by the banks.

PROCEDURE FOR CALCULATING CRR:

1.3 Computation of Demand and Time Liabilities:

Liabilities of a bank may be in the form of demand or time deposits or borrowings or

other miscellaneous items of liabilities. As defined under Section 42 of RBI Act, 1934,

liabilities of a bank may be towards banking system or towards others in the form of

demand and time deposits or borrowings or other miscellaneous items of liabilities. The

Reserve Bank of India has been authorised in terms of Section 42 (1C) of the RBI Act,

1934 to classify any particular liability and hence for any doubt regarding classification

of a particular liability, the banks are advised to approach the RBI for necessary

clarification.

1.4 Demand Liabilities:

Demand Liabilities include all liabilities which are payable on demand that include

current deposits, demand liabilities portion of savings bank deposits, margins held against

letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and

cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer

(MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit

account and deposits held as security for advances which are payable on demand. Money

at Call and Short Notice from outside the Banking System should be shown against

liability to others.

1.5 Time Liabilities:

Time Liabilities are those which are payable otherwise than on demand that include fixed

deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of

savings bank deposits, staff security deposits, margin held against letters of credit, if not

payable on demand, deposits held as securities for advances which are not payable on

demand and Gold deposits.

1.6 Other Demand and Time Liabilities (ODTL):

Other Demand and Time Liabilities (ODTL) include interest accrued on deposits, bills

payable, unpaid dividends, suspense account balances representing amounts due to other

banks or public, net credit balances in branch adjustment account, any amounts due to the

"Banking System" which are not in the nature of deposits or borrowing. Such liabilities

may arise due to items, like (i) collection of bills on behalf of other banks, (ii) interest

due to other banks and so on. If a bank cannot segregate the liabilities to the banking

system, from the total of "Other Demand and Time Liabilities" (ODTL) the entire 'Other

Demand and Time Liabilities' may be shown against item II (c) 'Other Demand and Time

Liabilities' of the return in Form 'A' and average CRR is required to be maintained on it

by all Scheduled Commercial Banks.

Participation Certificates issued to other banks, the balances outstanding in the blocked

account pertaining to segregated outstanding credit entries for more than 5 years in inter-

branch adjustment account, the margin money on bills purchased / discounted and gold

borrowed by banks from abroad, also should be included in ODTL.

1.7 Assets with the Banking System:

Assets with the banking system include balances with banks in current accounts, balances

with banks and notified financial institutions in other accounts, funds made available to

banking system by way of loans or deposits repayable at call or short notice of a fortnight

or less and loans other than money at call and short notice made available to the banking

system. Any other amounts due from banking system which cannot be classified under

any of the above items are also to be taken as assets with the banking system.

1.8 Borrowings from Banks Abroad:

Loans/borrowings from abroad by banks in India will be considered as 'liabilities to

others' and will be subject to reserve requirements.

Upper Tier II instruments raised and maintained abroad shall be reckoned as liability for

the computation of DTL for the purpose of reserve requirements.

1.9 Arrangements with Correspondent Banks for Remittance Facilities:

When a bank accepts funds from a client under its remittance facilities scheme, it

becomes a liability (liability to others) in its books. The liability of the bank accepting

funds will extinguish only when the correspondent bank honours the drafts issued by the

accepting bank to its customers. As such, the balance amount in respect of the drafts

issued by the accepting bank on its correspondent bank under the remittance facilities

scheme and remaining unpaid should be reflected in the accepting bank's books as

liability under the head ' Liability to others in India' and the same should also be taken

into account for computation of DTL for CRR/SLR purpose.

The amount received by correspondent banks has to be shown as 'Liability to the Banking

System' by them and not as 'Liability to others' and this liability could be netted off by the

correspondent banks against the inter-bank assets. Likewise sums placed by banks issuing

drafts/interest/dividend warrants are to be treated as 'Assets with Banking System' in their

books and can be netted off from their inter-bank liabilities.

1.10 Liabilities not to be included for DTL/NDTL computation:

The under-noted liabilities will not form part of liabilities for the purpose of CRR;

a. Paid up capital, reserves, any credit balance in the Profit & Loss Account of the

bank, amount of any loan taken from the RBI and the amount of refinance taken

from Exim Bank, NHB, NABARD, SIDBI.

b. Net income tax provision.

c. Amount received from DICGC towards claims and held by banks pending

adjustments thereof.

d. Amount received from ECGC by invoking the guarantee.

e. Amount received from insurance company on ad-hoc settlement of claims

pending judgment of the Court.

f. Amount received from the Court Receiver.

g. The liabilities arising on account of utilization of limits under Bankers

Acceptance Facility (BAF).

h. District Rural Development Agency (DRDA) subsidy of Rs.10,000/- kept in

Subsidy Reserve Fund account in the name of Self Help Groups.

i. Subsidy released by NABARD under Investment Subsidy Scheme for

Construction/Renovation/Expansion of Rural Godowns.

j. Net unrealized gain/loss arising from derivatives transaction under trading

portfolio.

k. Income flows received in advance such as annual fees and other charges which

are not refundable.

l. Bill rediscounted by a bank with eligible financial institutions as approved by

RBI.

m. Provision not being a specific liability arising from contracting additional liability

and created from profit and loss account.

1.11 Exempted Categories:

Scheduled Commercial Banks are exempted from maintaining CRR on the following

liabilities

i. Liabilities to the banking system in India as computed under Clause (d) of the

Explanation to Section 42(1) of the RBI Act, 1934.

ii. Credit balances in ACU (US$) Accounts.

iii. Demand and Time Liabilities in respect of their Offshore Banking Units (OBUs).

iv. Scheduled Commercial Banks are not required to include inter-bank term

deposits/term borrowing liabilities of original maturities of 15 days and above and

up to one year in "Liabilities to the Banking System" (item 1 of Form "A").

Similarly banks should exclude their inter-bank assets of term deposits and term

lending of original maturity of 15 days and above and up to one year in "Assets

with the Banking System" (item III of Form A) for the purpose of maintenance of

CRR. The interests accrued on these deposits are also exempted from reserve

requirements.

1.12 Loans out of FCNR (B) Deposits and IBFC Deposits

Loans out of Foreign Currency Non–Resident Accounts (Banks), (FCNR [B] Deposits

Scheme) and Inter-Bank Foreign Currency (IBFC) Deposits should be included as part of

bank credit while reporting in Form ’A’. For the purpose of reporting, banks should

convert their FCNR (B) Deposits, Overseas foreign currency assets and bank credit in

India in foreign currency in 4 major currencies into rupees at FEDAI noon mean rate on

the reporting Friday.

1.13 Maintenance of CRR on Daily Basis

With a view to providing flexibility to banks in choosing an optimum strategy of holding

reserves depending upon their intra fortnight cash flows, all Scheduled Commercial

Banks are required to maintain minimum CRR balances up to 70 per cent of the average

daily required reserves for a reporting fortnight on all days of the fortnight.

1.14 No Interest Payment on Eligible Cash Balances maintained  by SCBs with RBI

under CRR

In view of the amendment carried out to RBI Act 1934, omitting sub-section (1B) of

section 42, the Reserve Bank of India does not pay any interest on the CRR balances

maintained by Scheduled Commercial Banks with effect from the fortnight beginning

March 31, 2007.

1.15 Fortnightly Return in Form A

Under Section 42 (2) of RBI Act, 1934, all SCBs are required to submit to RBI a

provisional return in Form 'A' within 7 days from the expiry of the relevant fortnight. It is

used for preparing press communiqué. The final Form 'A' is required to be sent to RBI

within 20 days from expiry of the relevant fortnight. Based on the recommendation of the

Working Group on Money Supply: Analytics and Methodology of Compilation, all

Scheduled Commercial Banks in India are required to submit from the fortnight

beginning October 9, 1998, Memorandum to form 'A' return giving details about paid-up

capital, reserves, time deposits comprising short-term (of contractual maturity of one year

or less) and long-term (of contractual maturity of more than one year), certificates of

deposits, NDTL, total CRR requirement etc., Annexure A to Form ‘A’ return showing all

foreign currency liabilities and assets and Annexure B to Form ‘A’ return giving details

about investment in approved securities, investment in non-approved securities, memo

items such as subscription to shares /debentures / bonds in primary market and

subscriptions through private placement.

For reporting in Form 'A' return, banks should convert their overseas foreign currency

assets and bank credit in India in foreign currency in four major currencies viz., US

dollar, GBP, Japanese Yen and Euro into rupees at the Foreign Exchange Dealers

Association of India's (FEDAI) noon mean rate on reporting Friday.

1.16 Penalties

From the fortnight beginning June 24, 2006, penal interest will be charged as under in

cases of default in maintenance of CRR by Scheduled Commercial Banks:

(i) In cases of default in maintenance of CRR requirement on a daily basis which is

presently 70 per cent of the total CRR requirement, penal interest will be recovered for

that day at the rate of three per cent per annum above the Bank Rate on the amount by

which the amount actually maintained falls short of the prescribed minimum on that day

and if the shortfall continues on the next succeeding day/s, penal interest will be

recovered at a rate of five per cent per annum above the Bank Rate.

(ii) In cases of default in maintenance of CRR on average basis during a fortnight, penal

interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank

of India Act, 1934.

SCBs are required to furnish the particulars, such as date, amount, percentage, reason for

default in maintenance of requisite CRR and also action taken to avoid recurrence of such

default.

EXCEPTIONS TO MAINTENANCE OF CRR

Rural, co-op banks need not maintain CRR for CBLO

The Reserve Bank of India (RBI) has decided to exempt state cooperative banks (SCBs) and

regional rural banks (RRBs) from having cash reserve ratio (CRR) requirements on

Collateralised Borrowing and Lending Obligation (CBLO). However, SCBs have to maintain a

statutory CRR of 3 per cent.

 

The move is aimed at developing CBLO as a money market instrument.

 

Accordingly, SCBs and RRBs are required to include borrowing under CBLO under their net

demand and time liabilities (NDTL).

 

SCBs and RRBs are also required to maintain statutory liquidity ratio (SLR) of 25 per cent on

NDTL, including borrowing through CBLO.

IMPACT OF CRR

On banks:

If RBI decides to increase the percent of this, the available amount with the banks comes down.

RBI is using this method (increase of CRR rate), to drain out the excessive money from the

banks.CRR impact interest rates, when RBI increases CRR it means banks have to keep

additional funds with the RBI, if banks keep more with RBI they can offer less at high rate of

interest to customers. Hence RBI increases CRR when they want to take away the excess

money from markets and vice-versa. Liquidity in an economy also gets impacted with a change

in CRR, when RBI reduces CRR from time to time they plan to inject money into the system .

From a stock market perspective:

Rising interest rates have several implications including – * Results in slow down in the overall

growth in the economy; this effectively means that adverse impact of demand for goods and

services, and investment activity. * apart from the fact that overall growth is impacted,

companies take a hit on account of higher interest costs that they have to bear on their

outstanding loans (to the extent their cost of funds is not locked in) * since some investors tend

to leverage and invest in the stock markets, higher interest rates increase expectation of returns

from the stock markets; this has the impact of lowering current stock prices * an overall decline

in stock prices has a cascading effect as leveraged positions are unwound (on account of

meeting margin requirements), leading to still lower stock prices.

So, from a short term perspective, higher interest rates should adversely impact stock market

sentiment. From a long term perspective however our expectations of returns from the stock

markets remains unchanged. As mentioned earlier, RBI’s move to tame inflation over the long

term augurs well for long term economic growth (there is more predictability and therefore risk

premiums are lower). This will ultimately benefit well-managed companies.

 On Inflation:

Inflation shoots up with increased demand and reduced supply of goods. If inflation is to be

reduced , either demand should be reduced or supply should be increased. If the RBI increases

the CRR, banks have less funds to lend, which in effect means borrowing becomes costly, and

that reduces demand. Thus when you go to buy a TV or a refrigerator or a music system or a

car, the banks will not be as aggressive to lend you the money to buy such goods. Moreover

companies have to book high interests costs on their Profit & Loss statements and this reduces

profits. Reduced profits depress sentiments and hence demand. Further, banks reduce margin

money for trading in stocks, which means the stock market also slows down.

A reduction in CRR causes the opposite effect. It increased demand.

In order to increase supply, the governemnt has to take steps to reduce indirect trade barriers

like reducing duties, taxes etc on essential commodities.

From a debt market perspective

Higher interest rates will be favourable for investments in debt market.However, existing

investors in debt oriented funds may take a one time hit; but at the same time, since overall

interest rates are higher, from here on, such funds will yield higher returns.

On households and borrowers:

Banks might increase the base rate keeping in view of the consistent increase of policy rate viz.

repo rate and reverse rate by RBI. This increase has been in line with the expectations of

bankers. This is in turn lead to an increase in your housing loan rate, car loan rate and personal

loan rate.

As a prospective borrower, you are the worst hit. The cost of money i.e. interest rates will rise

post the CRR hike. You will probably need to settle in for a lower loan amount given the EMI.

If you are an existing borrower, as long as the rate of interest on your loan is fixed, you are

immune to any rise in interest rates. However, if you have a floating rate loan, then expect

either the tenure of the loan or the EMI to jump soon.

On real estate:

It remains to be seen what impact any rate increase may have on the real estate market. Past

rate increases have not. The RBI over the last two to three quarters has maintained a hard

stance on lending to real estate developers. The CRR hike will make flow to the builders

tighter. However, there will be a marginal impact on the cost of debt. The unwillingness of RBI

to support the real estate (developers) sector has already created a situation of credit slowdown

from banks. The move will only force developers to look more towards private equity, public

issue, placement albeit at a relatively higher cost. As private equity is not so cheap, banks have

so far remained the preferred source for most developers. Cost of funding is not an issue for big

developers; it’s the availability that matters. According to industry sources, some developers

have discovered innovative routes – such as clubbing infrastructure projects with realty plans –

to by-pass RBI guidelines.

On fixed deposits:

Any hike in CRR(Cash reserve Ratio) by Reserve Bank of India, requires the banks to keep

more reserves. Thus they would have less funds to generate income. This creates pressure on

bank income. In order to deal with this, the banks reduce the deposit rates.

 

3.STATUTORY LIQUIDITY RATIO

Consequent upon amendment to the Section 24 of the Banking Regulation Act, 1949 through

the Banking Regulation (Amendment) Act, 2007 replacing the Regulation (Amendment)

Ordinance, 2007, effective January 23, 2007, the Reserve Bank can prescribe the Statutory

Liquidity Ratio (SLR) for SCB in specified assets. The value of such assets of a SCB shall not

be less than such percentage not exceeding 40 per cent of its total demand and time liabilities in

India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by

notification in the Official Gazette, specify from time to time.

Reserve Bank has decided that all SCBs shall continue to maintain a uniform SLR of 24 per

cent on their total net demand and time liabilities (NDTL) with effect from the fortnight

beginning December 16, 2010, valued in accordance with the method of valuation specified by

the Reserve Bank of India from time to time:

a) in cash, or

b) in gold valued at a price not exceeding the current market price,

c) Unencumbered approved securities (G Secs or Gilts come under this) valued at a price as

specified by the RBI from time to time.

The main objectives for maintaining the Statutory Liquidity Ratio are the following:

Statutory Liquidity Ratio is maintained in order to control the expansion of Bank

Credit. By changing the level of Statutory Liquidity Ratio, Reserve bank of India can

increase or decrease bank credit expansion.

Statutory Liquidity Ratio in a way ensures the solvency of commercial banks.

By determining Statutory Liquidity Ratio, Reserve Bank of India, in a way, compels the

commercial banks to invest in government securities like government bonds.

2.1 Procedure for Computation of Statutory Liquidity Ratio (SLR)

The procedure to compute total net demand and time liabilities for the purpose of SLR under

Section 24 (2) (B) of B.R. Act 1949 is broadly similar to the procedure followed for CRR

purpose. The liabilities mentioned under Section 1.11 will not form part of liabilities for the

purpose of SLR also. Scheduled Commercial Banks are required to include inter-bank term

deposits / term borrowing liabilities of all maturities in 'Liabilities to the Banking System'.

Similarly banks should include their inter-bank assets of term deposits and term lending of all

maturities in 'Assets with the Banking System' for computation of NDTL for SLR purpose.

2.2 Classification and Valuation of Approved Securities for SLR

As regards classification and valuation of approved securities, banks may be guided by the

instructions contained in our Master Circular (as updated from time to time) on Prudential

Norms for classification, valuation and operation of investment portfolio by banks.

2.3 Penalties

If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to

RBI in respect of that default, the penal interest for that day at the rate of 3 per cent per annum

above the Bank Rate on the shortfall and if the default continues on the next succeeding

working day, the penal interest may be increased to a rate of 5 per cent per annum above the

Bank Rate for the concerned days of default on the shortfall.

2.4 Return in Form VIII to be submitted to RBI

i. Banks should submit to the RBI before 20th day of every month, a return in Form VIII

showing the amounts of SLR held on alternate Fridays during immediate preceding

month with particulars of their DTL in India held on such Fridays or if any such Friday

is a Public Holiday under the Negotiable Instruments Act, 1881 at the close of business

on preceding working day.

ii. Banks should also submit a statement as annexure to form VIII giving daily position of

(a) value of securities held for the purpose of compliance with SLR and (b) the excess

cash balances maintained by them with RBI in the prescribed format.

 

2.5 Temporary/Ad-hoc measures

At present banks obtain liquidity from the Reserve Bank under the liquidity adjustment facility

(LAF) against the collateral of eligible securities that are in excess of their prescribed statutory

liquidity ratio (SLR). In addition, purely as a temporary measure, scheduled commercial banks

may avail additional liquidity support under the LAF to the extent of up to 0.5 per cent of their

net demand and time liabilities.

IMPACT OF SLR

On banks:

Any reduction in the SLR level increases the amount of money available with banks for lending

to individuals, companies or other banks. Any hike in the SLR has the opposite effect.

On borrowers:

A reduction in SLR, ideally, means the borrowers should have to pay a cheaper rate of interest

on their loans and vice versa.

Call money market:

Call market enables commercial bank to minimum their statutory reserve requirements.

Generally banks borrow on a large scale every reporting Friday to meet their SLR

requirements. In absence of call market, banks have to maintain idle cash to meet their reserve

requirements. It will tell upon their profitability.

On inflation and liquidity:

In the current scenario, a slight decrease in SLR will not adversely affect the inflationary trend

but helps in increasing the liquidity in the market.

PROS AND CONS OF DECREASE IN SLR

ADVERSELY IMPACTS FISCAL DEFICIT:

The money markets have seen a major shift in terms of the liquidity that has been in the system

since the start of the financial year. With tight liquidity conditions, which is consistent with

RBI’s policy stance, one does not subscribe to the view that statutory liquidity ratio (SLR)

should be reduced for the following reasons. Banks accept public deposits and are in a way

repositories of public trust, and the confidence reposed by investors in institutions is very

important from the financial markets perspective. Investment in government bonds (SLR) acts

as a macro prudential tool. In the current context when worldwide banks are being criticised for

having risky asset portfolios, there is a perceptible shift among banks’ asset portfolios from

credit and other derivative instruments to holdings of sovereign government bonds. Indian

banks have been able to withstand the storm due to these prudent polices of the Reserve Bank

of India and it is, therefore, not the time to reduce the proportion of risk-free holdings. Also,

SLR is not a liquidity management tool but a measure for risk mitigation and, hence, should not

be changed frequently. In fact, SLR has been constant except for a brief tweaking in the

aftermath of the global financial crises. A lowering of SLR has adverse implications for

managing a large fiscal deficit. The government’s borrowing programme has been

unprecedented in the last two years, averaging around Rs 4.5 lakh crore. Banks are large

subscribers of government bonds and help manage the borrowings programme. It is expected

that the government will return to the path of fiscal consolidation after having weathered the

crises in totality. Thus, a reduction in SLR should be concomitant with a lower fiscal deficit

and, at this juncture, would not be the right step. Lastly, the credit growth has been lower than

expected this year but, despite that, economic growth continues to be robust largely on the back

of non-banking sources of finance. Hence, the argument for a reduction in SLR to augment

lendable resources of banks also does not seem tenable at present.1

IMPROVES CREDIT FLOWS TO PRIVATE COMPANIES:

The current level of SLR, however, appears high for growth of the banking system. India is no

longer a restricted economy where the state is the sole funding source for development projects.

The increase in private sector participation in the infrastructure sector lowers the need to

channel resources to the government sector. The focus, therefore, should be to boost

participation of the private sector. This can be done by providing ready access to debt finance

instead of redistributing liquidity artificially in favour of the government sector and creating a

demand-supply gap for private sector funding that, in turn, pushes up the cost of funds. This,

coupled with low-yielding government assets, impedes credit growth and erodes profitability of

the banking sector. A high level of SLR also distorts the interest rate structure and its

usefulness as a signaling mechanism. Compliance with SLR targets compels banks to invest in

government bonds, rather than allowing demand and prices of such securities to be determined

by market forces. This availability of captive buyers for government bonds also lessens the

need for fiscal discipline and limits the depth of the government debt market, as the

government has little incentive to look for alternate and efficient funding sources outside the

banks. Higher SLR also increases market risk for banks due to the sheer size of holdings of

these price-sensitive securities. This, in turn, directly limits the ability of banks to absorb other

types of market risks, including those arising from corporate debt securities. Thus, not just does

a high SLR crowd out private sector credit; it also indirectly impedes the development of a

1 Pradeep Madhav, MD of STCI primary dealer

deeper corporate bond market. Though SLR is used in India, other countries have similar

solvency ratios. However, such solvency measures prevalent in most other emerging markets

continue to be lower than that in India. Therefore, lowering the SLR in India will help continue

the positive trend resulting from several past reductions in this ratio.2

 

 

 

 

4.CONCLUSION

The RBI is considered to be one of the most effective regulators of financial system in this

world. The reason behind the success of RBI maintaining a stable and a well managed financial

system is its Monetary Policy which prescribes strict rules and regulations for maintenance of

statutory reserves called the CASH RESERVE RATIO and STATUTORY LIQUIDITY

RATIO.

CRR and SLR may achieve a similar objective but they perform their roles in different manner.

While CRR aims to maintain a portion of bank’s liquidity with the Central Bank, SLR achieves

the same purpose by asking the banks to maintain a portion of their liquid assets with

themselves.

CRR is that liquid portion of commercial banks which remains in the control of the Central

Bank. While SLR is the liquid asset maintenance with the bank itself. The regulation and utility

2 Hitendra Dave, MD(global markets) HSBC

of SLR lies with the commercial banks.

The idea behind maintaining two different liquidity parameters is to ensure efficient regulation

of the Current assets. If there is only one rate, monetary tools in the hands of Central authority

will get minimized. With different liquidity tools, better regulation with superior monetary

policies can be ensured.

The purpose of CRR and SLR is the same, but their time and method of implementation vary at

a great extent, and this is what impacts the monetary policy the most.

 

 

 

 

Bibliography:

1. Tannan’s priciples of banking

2. http://rbidocs.rbi.org.in/rdocs/notification/PDFs/55663.pdf

3. http://www.cluteinstitute-onlinejournals.com/PDFs/2006236.pdf

4. http://www.skylinecollege.com/blog/finance/impact-of-crr-as-a-monetary-tool-in-

indian-economy

5. http://www.rediff.com/money/2002/apr/25tut.htm

6. http://www.business-standard.com/india/news/rural-co-op-banks-need-not-

maintain-crr-for-cblo/229819

7. http://suchintya.blogspot.com/2007/08/crr-and-inflation.html

8. http://www.speedresearch.com/stock_article.asp?aid=330

9. http://stockthoughts.wordpress.com/2008/04/05/what-is-cash-reserve-ratio-and-

how-will-the-crr-hike-impact-you/

10. http://allbankingsolutions.com/repo.htm

11. http://in.answers.yahoo.com/question/index?qid=20081124080335AAknjOr

12. http://www.engineersfinance.com/blog/2008/07/28/statutory-liquidity-ratio-slr/

13. http://www.peerpower.com/et/debate/85/Should-the-RBI-decrease-SLR-