CRR and SLR

Have you ever nodded confidently in agreement with a friend as he/she waxed eloquent on CRR, SLR and other such terms ending in “R” that you didn’t quite understand?

I know I have.

Now that I’m old (-er) and grey (I’ve been greying since I was 18. L’Oreal hair dye is the secret to my apparent youth. Don’t tell anyone), I say the following alarmingly often and with an amusing (to many) lack of embarrassment.

“What does that mean?”

“I have no idea.”

“Whaaaaaaaat?” (Sometimes followed by words I cannot type on this blog without being judged).

Since you may not suffer from the same lack of embarrassment as I do, I’m going to help you out by demystifying CRR and SLR in this post.

Then you can have a “Kulwant Bhatia” moment. He’s the chubby, hilarious Sardar dude in this Indiabulls addvertisment below (youtube link provided). Be sure to check it out - if you don’t laugh, I’ll shave (whoops - sorry), I mean.....grow my hair.

                                                                                                                    

https://www.youtube.com/watch?v=kGz445o2KzU

What is CRR?

The Cash Reserve Ratio (CRR) is the proportion of a bank’s Net Demand and Time Liabilities (NDTL) that is has to keep as cash with the RBI. While we’ll explain in detail what comprises the NDTL of banks in another post, what it broadly refers to is total bank deposits. Hence, CRR is the % of total deposit funds that banks have to maintain as cash with the RBI.

The CRR is currently at 4%.  This means, of every Rs. 100 in deposits, a bank must keep Rs. 4 with the RBI.  It has Rs. 96 left for lending and meeting other regulatory requirements. Note: the CRR funds kept with the RBI earn no interest.

Objectives of CRR

The objectives of having a CRR requirement are:

• Ensuring that banks have adequate funds to meet payment/ withdrawal demands from their depositors.

• The CRR is also a tool of monetary control for the RBI. It can be used to increase/decrease money supply and manage inflation. For example, an increase in the CRR means that a higher proportion of bank deposits has to be parked as cash with the RBI. This means that banks have less money to lend which reduces the money supply through the “multiplier” effect (eminently deserving of a separate post which I will most certainly do). Lower money supply means less money is chasing the same number of goods (lower demand for goods), which helps lower inflation.                                                                                                                                                                    I’m going to explain this same process from the banks’ perspective. An increase in CRR means an increase in idle funds (remember – CRR funds don’t earn any interest) and a decrease in loanable funds for banks. In order to preserve profits, banks tend to increase lending rates. An increase in lending rates leads to a drop in demand for loans from retail and corporate customers, who consequently tend to spend/consume less which reduces the demand for goods & services. As a result, inflation tends to fall.

What is SLR?

The Statutory Liquidity Ratio (SLR) is the % of a bank’s NDTL that it has to maintain as investments in assets specified by the RBI, which include cash, gold and government securities. The SLR is currently at 21.5%. This means that of every Rs. 100 in deposits, a bank must invest Rs. 21.5 in SLR assets (mostly government bonds). Even thought the SLR is at 21.5%, Indian banks currently hold around 29-30% of their NDTL in SLR-approved assets/ securities.

Objectives of SLR

The objectives of having an SLR requirement are:

• To ensure that banks are able to return to their depositors, the full (par) value of their deposits at maturity, along with interest as and when promised. Besides the CRR, the RBI does this through the SLR by requiring banks to deploy a fixed % of their deposit funds in government securities (g-secs), considered the safest assets available.  In finance speak, the objective of SLR is to ensure the “solvency” of banks.

• The other objective is providing a large captive market for government bonds through the mandatory SLR requirement. This allows the government to finance its fiscal deficit at lower rates.  In the absence of the SLR requirement, banks would voluntarily invest a lower amount in g-secs, which would drive up yields and significantly raise the government’s borrowing costs.

• SLR can also be used to control the expansion of credit in the economy. When the SLR is lowered, banks have more funds available for lending. This allows banks to lower interest rates without impacting profit margins, which in turn leads to an expansion in bank credit. Bank credit expansion leads to increased economic activity/spending. This can also engender an increase in inflation. The opposite happens when the SLR is lowered.  

History

Till 2007, the minimum value of CRR was fixed at 3% and the maximum value was fixed at 20%. These limits were abolished in 2007 by an amendment of the RBI Act. Currently, the CRR is at 4%.

Similarly, before 2007, the maximum and minimum limits for the SLR were 40% and 25%. In Jan 2007, after the amendment of the Banking regulation Act, the minimum limit of 25% was removed. Today, the SLR is at 21.5%.

I’m going to do some related/follow-up posts soon.

Watch this space.