Reserve Bank of India (RBI), the central bank, one of its primary functions is to control the supply as well as the cost of credit. Which means how much money is available for the industry or the economy and what is the price that the economy has to pay to borrow that money which is nothing but liquidity and interest rates.
So, RBI has a role to play to control these two things because eventually these two have an impact on the inflation and growth in the economy. For this, RBI has got some tools available in their hands and these tools are maintaining certain basic ratios or maintaining certain rates.
Repo rate is a rate at which banks borrow from RBI for short periods up to 7 or 14 days but predominantly overnight. RBI manages this repo rate which is the cost of credit for the bank. This becomes a floor below which the short-term interest rates don’t go. Higher the repo rate means the cost of short-term money is very high. Lower the repo rate means the cost of short-term rate is low which means at higher repo rates the economy growth may slowdown whereas at lower repo rate economy growth may get enhanced.
CRR and SLR are the two ratios. CRR is a cash reserve ratio and SLR is statutory liquidity ratio. Under CRR a certain percentage of the total bank deposits has to be kept in the current account with RBI which means banks do not have access to that much amount for any economic activity or commercial activity. Banks can’t lend the money to corporates or individual borrowers, banks can’t use that money for investment purposes. So, that CRR remains in current account and banks don’t earn anything on that.
SLR, statutory liquidity ratio is the amount of money that is invested in certain specified securities predominantly central government and state government securities. Once again this percentage is of the percentage of the total bank deposits available as far as the particular bank is concerned. The SLR, the money goes into investment predominantly in the central government securities as I mentioned earlier which means the banks earn some amount of interest on that investment as against CRR where it earns zero.
Let us look at this combination of CRR and SLR. That is the amount of money which remains blocked for statutory reasons and is not available for investment in various other high earning avenues like loans are securities markets or other bonds. That means it puts a certain amount of pressure on the banks balance sheets. However, at the same time that money remains safe and with that mechanism RBI also offers safety to the depositors who have invested money in the banks.
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