What are Reserve ratios?

CRR and SLR are reserve ratios.

CRR: CRR stands for Cash Reserve Ratio. CRR is the amount of deposits that all Indian Scheduled Commercial Banks (SCB) need to keep with the RBI (Reserve Bank of India)-India’s central bank. CRR is expressed in percentage and any change in CRR is declared in basis-points. 

100 basis points are equivalent to a per cent.

There is no floor or ceiling  for CRR.

Example: A CRR of 5 % means, every scheduled commercial bank has to park 5 % of its deposit with the RBI and a reduction of 50 basis-points (or .5 %) in CRR shall result in new CRR rate as 4.5 %.

Demand deposits and time deposits are collectively called as DTL (Demand and Time Liability) - as deposits with banks are liabilities for banks.

Point to be noted is CRR is expressed as a percentage of total DTL.

The term deposit means all Demand and Time deposits. FDs and RDs are the most common forms of Time Deposit while current account deposits and savings account deposits fall under Demand Deposits. 

Presently no interest is paid on CRR deposits.

SLR: SLR stands or ‘Statutory Liquidity Ratio’ is the ratio of liquid assets to net DTL (Demand and Time Liability) which every Indian bank has to maintained on the ‘end of day’ basis.

Simply put, every Indian bank need to put a fixed proportion of its net DTL(Demand and Time Liability) in liquid assets like cash, gold and non-encumbered approved securities.

Treasury bills of GOI are a commonly used security for SLR requirement.

Point to be noted is that CRR is expressed as a percentage of total DTL (Demand and Time Liability) while SLR is calculated on net DTL.

Besides CRR, banks need to comply with the SLR obligation.

RBI can raise this ratio up to 40 % at the most.

Non-maintenance of SLR by a bank makes it liable for the penalty at the rate equal to Bank rate + 3% p.a.

By this date, CRR is 4.5 % and SLR is 23 %. This means banks can’t lend 27.5 % of their deposits which remains stuck in reserve ratio requirements.

Implications of Reserve Ratio changes:

The very purpose of Reserve Ratios is to keep banks liquid at any point of time.

A reduction in CRR releases money in the financial system and more money could reduce the prevailing interest rates. Lower interest rates are good for businesses and the banking sector.

To suck the excess liquidity (which generally results in higher inflation) out of the financial system, RBI often raises Reserve Ratios.