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Banking and Insurance

Notes Reserve Requirements (CRR, SLR)

Another significant power that central banks hold is the ability to establish reserve requirements
for other banks. By requiring that a percentage of liabilities be held as cash or deposited with the
central bank (or other agency), limits are set on the money supply.
In practice, many banks are required to hold a percentage of their deposits as reserves. Such
legal reserve requirements were introduced in the nineteenth century to reduce the risk of
banks overextending themselves and suffering from bank runs, as this could lead to knock-on
effects on other banks. Even if reserves were not a legal requirement, prudence would ensure
that banks would hold a certain percentage of their assets in the form of cash reserves.

Cash Reserve Ratio (CRR)

The present banking system is called a “fractional reserve banking system”, as the banks are
required to keep only a fraction of their deposit liabilities in the form of liquid cash with the
central bank to ensure safety and liquidity of deposits.
The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain with the
Reserve Bank of India (RBI) as a certain percentage of their demand and time liabilities.

Example: If the CRR is 10% then a bank with net demand and time deposits of Rs 1,00,000
will have to deposit Rs 10,000 with the RBI as liquid cash.
The CRR is applicable to all scheduled banks including the scheduled cooperative banks and the
Regional Rural Banks (RRBs).
At present, the RBI does not pay any interest to the banks on the CRR deposits. Prior to 1962, a
separate CRR was fixed in respect of demand and time liabilities. However, after 1962, the
separate CRRs were merged and one CRR came into effect for both demand and time deposits of
banks with the RBI.

CRR–A tool of credit control

CRR was introduced in 1950 chiefly as a measure to guarantee safety and liquidity of bank
deposits. However over the years it has become an important and effective tool for directly
regulating the lending capacity of banks and controlling the money supply in the economy.
When the RBI feels that the money supply is increasing and causing an upward pressure on
inflation, the RBI has the option of increasing the CRR thereby reducing the deposits available
with banks to make loans and hence reducing the money supply and inflation and vice versa.
The RBI has the authority to impose penal interest rates on the banks in respect of their shortfalls
in the prescribed CRR. In fact, if the default continues on a basis RBI can even cancel the bank’s
license or force it to merge with a larger bank.

Statutory Liquidity Ratio (SLR)

Statutory Liquidity Ratio or SLR refers to the amount that all banks require to maintain in cash
or in the form of gold or approved securities. Approved securities mean bond and shares of
different companies. Thus, Statutory Liquidity Ratio is determined as percentage of total demand
and percentage of time liabilities.
The money deposited by commercial banks at the central bank is the real money in the banking
system; other versions of what is commonly thought of as money are merely promises to pay

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