Definition
CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) are two crucial monetary policy tools the central bank uses to control liquidity and inflation in the economy. CRR refers to the minimum percentage of a bank’s total deposits that must be kept in the form of cash with the central bank. SLR, on the other hand, is the percentage of deposits that banks must maintain in the form of gold, government bonds, or other approved securities.
Key Takeaways
- CRR (Cash Reserve Ratio) refers to the minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves with the central bank. This is either in the form of actual cash or as reserves with the central bank. This acts as a safeguard measure, ensuring that the bank has enough funds to pay back to its depositors on demand.
- SLR (Statutory Liquidity Ratio) is the Indian government term for the reserve requirement that the commercial banks in India require to maintain in the form of gold, cash or other approved securities. It intends to prevent the bank from going bankrupt and ensure the bank has sufficient funds to meet the obligations of depositors.
- The main difference between CRR and SLR is in how it is used. CRR is used to ensure that banks do not run out of cash to meet the payment demands of its depositors whereas the SLR is used to ensure that the banks do not lend out their entire deposits and retain a certain amount of capital to prevent bankruptcy.
Importance
The finance terms CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) are important as they are critical monetary policy tools used by a central bank to control liquidity and inflation in an economy. CRR is the percentage of deposits that banks must maintain with the central bank in cash form.
It influences the lending capacity of banks, hence impacting the money supply in the market. On the other hand, SLR is the percentage of deposits that banks have to invest in certain specified securities, predominantly government bonds.
It ensures banks maintain a safety buffer of liquid assets which can be sold quickly in case of a bank run, thereby adding a layer of security to the financial system. These ratios are adjusted by the central bank to manage growth, control inflation, and stabilize the banking sector.
Explanation
The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are two monetary policy tools used by central banks to regulate the amount of funds that commercial banks can extend as loans to their customers. The primary purpose of these tools is to ensure the financial stability of an economy, control inflation and provide a safety cushion in case of sudden financial crisis. CRR refers to the percentage of depositors’ balances that banks are required to keep with the central bank.
By adjusting the CRR, the central bank can control the liquidity in the banking system. For instance, a higher CRR reduces the amount of money available for lending, which can help slow down an overheating economy. On the other hand, SLR is the percentage of deposits that banks must maintain in safe and liquid assets, such as government bonds, gold or cash.
The main purpose of SLR is to restrict the banks from lending all the deposits and maintain a safety buffer of liquid assets. If a bank failed or a sudden mass withdrawal (a bank run) occurred, these assets would be used to satisfy depositor demands. These tools collectively help enhance the resilience and stability of the banking sector.
Examples of CRR vs SLR
The Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) are financial terms used predominantly in the banking sector. They are tools used by central banks to control the liquidity in the economy.
Example 1 – Controlling Inflation: If a country, like India, faces high inflation, the Reserve Bank of India (RBI) may increase the CRR to make it expensive for banks to lend to consumers. This will in turn decrease money circulation, leading to a decrease in inflation. In 2010, RBI raised the CRR from 5% to 6% to absorb excess liquidity due to inflationary pressure.
Example 2 – Boosting economic activity: During the COVID-19 pandemic, to foster economic recovery, the central bank (like RBI) may lower the SLR and CRR. This makes it easier for commercial banks to lend to businesses and consumers, thereby stimulating economic activity. In May 2020, the RBI reduced the CRR from 4% to 3% to boost liquidity amid the economic impact of the pandemic.
Example 3 – Ensuring bank’s financial health: In the wake of the 2008 global financial crisis, the CRR and SLR acted as safeguards to ensure that banks had sufficient cash and liquid assets. Banks with high SLR were better positioned to meet their liabilities. Similarly, those with a high CRR had a better cash buffer. These ratios allowed central banks to protect the banking system and prevent its collapse during a financial crisis. These examples are dependent on various economic factors and may not apply in all situations. The effects of changes in CRR and SLR can also be influenced by other monetary policy tools.
FAQs: CRR vs SLR
What is CRR?
CRR or Cash Reserve Ratio is the percentage of total deposits that commercial banks are required to maintain as reserves with the Central Bank. This is either in the form of actual money or something that can be readily converted into money at short notice.
What is SLR?
SLR or Statutory Liquidity Ratio is the amount that a commercial bank needs to maintain in the form of cash, gold or approved securities. The central bank determines SLR, and it is used to control the bank’s leverage for credit expansion.
What are the key differences between CRR and SLR?
The main difference between CRR and SLR is the form in which banks are required to maintain the reserves. CRR is to be kept as cash, while SLR can be maintained in cash, gold or approved securities. The percentage of money to be kept as CRR or SLR is also different and is determined by the Central Bank. CRR is a more liquid form of reserve and doesn’t earn any interest. In contrast, SLR can earn a small return.
When are CRR and SLR used by the Central Bank?
Both CRR and SLR are used by the Central Bank as monetary policy instruments. They can increase or decrease the ratios to control inflation, stabilize the banking system and spur economic growth. For example, during inflation, the Central Bank can increase both ratios to reduce the lending capacity of the banks, thereby restraining supply of excess money.
Related Entrepreneurship Terms
- Cash Reserve Ratio (CRR)
- Statutory Liquidity Ratio (SLR)
- Liquid Assets
- Bank Rate
- Reserve Bank of India (RBI)
Sources for More Information
- Investopedia: A comprehensive source of articles, financial dictionary entries and tutorials on finance and investing topics.
- Economics Help: An excellent resource for understanding economic terms, concepts and theories.
- Reserve Bank of India (RBI): Official website of the central bank of India. It’s a reliable source of information, especially when it comes to specific Indian banking norms like CRR and SLR.
- Bank for International Settlements (BIS): An international financial organization that serves as a bank for central banks. Its publications and reports can be used to understand financial terms and concepts.
