How CRR and SLR impact on bank credits?

Edited on 20.10.2022

Every commercial bank in India has to maintain reserves under statutory provisioning norms. The change in SLR and CRR either increases or decreases the money supply to commercial banks. This, in turn, affects the lendable resources of banks. Therefore ups and downs of the money supply to the market caused due to the variation of SLR and CRR have a direct impact on the economy of the country. RBI uses Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)  as a tool for the expansion or contraction of bank credit which has a direct impact on the economy in the situation of inflation or deflation.

Statutory Liquidity Ratio: The maintenance of liquid assets by commercial banks at the rate fixed by RBI is called Statutory Liquidity Ratio regulation. SLR ensures the liquidity and solvency of banks which is fundamental for a sound banking system. Every scheduled bank in India requires maintaining liquid assets in the form of cash, gold, and unencumbered approved securities and value of which shall not be less than 25 percent of the demand and time liabilities of the bank. The implication of change in SLR is the same as the change in CRR in regulating the expansion of credit. SLR is a statutory provision under Section 24 of the Banking Regulation Act 1949 and it is in addition Cash Reserve Ratio to be maintained by the bank. The SLR regulation is binding on all commercial banks in India.RBI is with the power to increase the SLR rate, as and when it desires to do so. An increase in the SLR rate means that commercial banks shall have to invest more money in Government and other approved securities which deplete the lendable source of the banks.

Cash reserve ratio: Cash reserve ratio is a statutory provision regulated by RBI under Section 42(1) of the Reserve Bank of India Act 1934. Every scheduled bank in India requires to maintain an average balance with the Reserve Bank of India, which shall not be less than 3 percent of the demand and time liabilities of the bank. This is a statutory provision,  binding on scheduled banks to maintain a minimum balance at a rate decided by RBI from time to time. Apart from the above minimum balance of the Cash Reserve Ratio, RBI is empowered to increase it by notification up to 15 percent under the Act. For example, the present CRR is 4.5%,

RBI tries to curb inflation by increasing the CRR, wherein banks have to keep more balance with RBI, thus their lend-able resource depletes. The depleted lend-able resource of banks has a direct effect on the economy. When banks lend less, the money supply in the economy becomes scarce, naturally, the demand for money goes up. The demand for more money due to the increase in CRR by RBI along with other regulatory actions such as increasing the SLR limit, bank rate, repo rate, etc,  helps in curbing inflation. There will be a vice versa effect when RBI cuts the CRR rate, to encourage bank lending, thereby more credits available to Industries and other entrepreneurs, thus accelerating economic activities.   

Click for related articles:

(i)Do you know that Repo auction framework is different from Repo rate? (ii) What is bank rate? (iii)  What is Marginal Standing Facility, (iv) Effects of Repo rate, Reverse repo rate changes