What is the role of RBI
To control or handle the supply of money in the economy means to check that how much money is available for the industry or for the economy and ‘the cost of credit.’ which means the price that has to pay by the economy has to borrow that money.
These two things (Supply of money and cost of credit) are managed and controlled by RBI. Inflation and growth in the economy are also impacted by these two factors.
For this RBI uses various methods that are classified into two groups
i. Quantitative controls
ii. Qualitative controls.
Quantitative controls regulate the credit cost created by the banking system. And qualitative measures or selective method regulates the flow of credit in specific uses.
For managing inflation and growth, RBI uses some tools like cash reserve ratio, statutory liquidity ratio, the repo rate, and reverse repo rate.
Cash Reserve Ratio (CRR)
Cash Reserve Ratio (CRR) means the share of a bank total deposit that is handled by the Reserve Bank of India (RBI) to be maintained with the bank in the form of liquid cash.
Cash Reserve Ratio Objective
Cash Reserve Ratio acts as the reference rates which determine the base rate. The base rate means the minimum lending rate below which a bank is not allowed to lend funds. This rate is determined by the Reserve Bank of India (RBI). The rate is fixed and used to make the system transparent borrowing and lending in the credit market.
It is one of the important and effective tools which regulate the lending capacity of banks and control the supply of money in the economy. When RBI feels that the supply of money is increasing in the market and it cause upward pressure on inflation, then RBI has an option to increase the CRR so that money available in the bank for loan reduce and by this RBI control the supply of money and inflation. The cash balance which is managed by scheduled banks with the RBI should not be less than 4% of total NDTL (Net Demand and Time Liabilities).
The simple meaning of CRR is on increasing the Cash Reserve Ratio, there is less amount of money available in banks for lending and investing.
In which Way CRR handle the economy
Cash Reserve Ratio (CRR) is the main component of the RBI monetary policy, which controls the money supply, inflation, and liquidity in the country. With increasing CRR, the lower is the liquidity with the banks.
At the time of inflation, RBI increases the CRR for reducing the flow of money in the economy which decreases the loan funds available in banks which slows down the investment and reduces the supply of money in the economy. So that the growth of the economy is impacted negatively..
And on the other side when RBI needs to increase the funds in the system, it decreases the CRR. which increases the loan funds in banks. Then banks start giving a large number of loans to businesses and industries for various investment purposes. And it also increases the supply of money in the economy.
Is there any need to change the Cash Reserve Ratio Regularly?
RBI set up some guidelines in which every bank has to maintain a ratio of their total deposits that can also be held with currency. This is the same as it is handled by the RBI. The RBI can change this ratio from time to time at regular intervals. This ratio impacts the economy when changed.
Most of the profit made by the bank is through lending. To achieve this goal, banks give loans to make a large profit and have very little cash with them. But when an unexpected need arises by customers to withdraw their deposit money then the bank will not be able to deal with their problems. For that RBI made such a function to control the bank activity which is CRR by which there is always some fraction of all the deposit money in every bank, kept safe with them.
To ensure liquidity against deposit money is the major function of the CRR. It also has an important role in controlling the interest rates in the economy. The RBI controls the short-term volatility in the interest rates by adjusting the amount of liquidity available in the system. If there is too much cash availability it leads to the fall in rates and if there is less case available then it leads to a sudden rise in rates, and both of them are unhealthy for the economy.
So if you are a depositor, it is good for you to know of the CRR value in the market that shows that regardless of the performance of the bank, some amount of percentage of your cash is safe by the RBI.
Statutory Liquidity Ratio (SLR)
How Statutory Liquidity Ratio Work
Every bank has a specific portion of their Net Demand and Time Liabilities (NDTL) in the form of cash, gold, or other liquid assets at the end of the day. The ratio of these liquid assets to the demand and time liabilities is called the Statutory Liquidity Ratio (SLR). The Reserve Bank of India has the power to increase this ratio by up to 40%. This increase in the ratio gives the ability to the bank to inject money into the economy.
RBI is also responsible to regulate the flow of money and stability of prices to run the Indian economy. Statutory Liquidity Ratio is one of the monetary policy of RBI. SLR is the instrument which ensures the solvency of the banks and cash flow in the economy.
Statutory Liquidity Ratio Components
Section 24 and Section 56 of the Banking Regulation Act 1949 made a compulsory provision for all scheduled commercial banks, local area banks, Primary (Urban) co-operative banks (UCBs), state co-operative banks and central co-operative banks in India to maintain the SLR. The components of SLR are:-
a) Liquid Assets-These is assets that can be easily converted into cash by anyone such as gold, treasury bills, govt-approved securities, government bonds, and cash reserves. It also consists of securities that are eligible under Market Stabilisation Schemes and come under the Market Borrowing Programmes.
b) Net Demand and Time Liabilities (NDTL)-NDTL means total demand and time liabilities (deposits) which are held by the banks. It consists of deposits of the general public and the balances take by the bank with other banks. Demand deposits consist of all liabilities that bank pay on demand like current deposits, demand drafts, saving bank deposits. Time deposits are those deposits that will be repaid on maturity, where the depositor will not be able to withdraw his deposit money immediately. The only way in this method is that the depositor will have to wait when the time of that deposit is not over. Fixed deposits, time liabilities portion of savings bank deposits, and staff security deposits are some examples.
c) SLR Limit- The upper limit of SLR is 40% and the lower limit is 23%
Statutory Liquidity Ratio Objectives
a) It curtail the commercial banks from over liquidating:
A bank or financial institution in the absence of SLR experience over-liquidation when the Cash Reserve Ratio goes up and the bank is in very much need of funds. RBI put SLR regulation to take control over the bank credit. SLR checks that whether there is solvency in commercial banks and assures that banks invest in government securities.
b) Increase or decrease the flow of bank credit:
The Reserve Bank of India raises the SLR to control the bank credit at the time of inflation and decreases the SLR at the time of recession to increase bank credit.
Impact of SLR on the Investor
The Statutory Liquidity Ratio acts as reference rates when RBI determines the base rate.
When RBI imposes any reserve requirement then it checks that a certain portion of the deposits are safe or not and whether it is available for customers to redeem. This condition also restricts the lending capacity of the bank. It is just to control the demand.
“The views of the authors are personal“
Frequently Asked Questions
What is SLR and CRR at present in 2019?
The current Statutory Liquidity Ratio is 19.00% and the current Cash Reserve Ratio is 4%
What is the monetary policy of RBI in 2020?
RBI framed some monetary policy for the country which mainly aimed to control inflation, regulate the supply of money, and cost of credit in the economy. For this RBI has some objectives such as:-
a. Controlling imports and exports
b. Promotion of Saving and investment
c. Development of Infrastructure
d. Employment Generation