Chapter 3 – Funding and Regulatory Aspects

CRR

Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with the latter in the form of liquid cash.

The Cash Reserve Ratio acts as one of the reference rates when determining the base rate. Base rate means the minimum lending rate below which a bank is not allowed to lend funds. The base rate is determined by the Reserve Bank of India (RBI). The rate is fixed and ensures transparency with respect to borrowing and lending in the credit market. The Base Rate also helps the banks to cut down on their cost of lending to be able to extend affordable loans. Apart from this, there are two main objectives of the Cash Reserve Ratio:

1. Cash Reserve Ratio ensures that a part of the bank’s deposit is with the Central Bank and is hence, secure.
2. Another objective of CRR is to keep inflation under control. During high inflation in the economy, RBI raises the CRR to lower the bank’s loanable funds.

Cash Reserve Ratio (CRR) is one of the main components of the RBI’s monetary policy, which is used to regulate the money supply, level of inflation and liquidity in the country. The higher the CRR, the lower is the liquidity with the banks and vice-versa. During high levels of inflation, attempts are made to reduce the flow of money in the economy. For this, RBI increases the CRR, lowering the loanable funds available with the banks. This, in turn, slows down investment and reduces the supply of money in the economy. As a result, the growth of the economy is negatively impacted. However, this also helps bring down inflation. On the other hand, when the RBI needs to pump funds into the system, it lowers CRR. which increases the loanable funds with the banks. The banks thus extend a large number of loans to businesses and industry for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.

SLR

In Indian banking terms, statutory liquidity ratio (SLR) refers to the minimum reserve requirement that needs to be maintained by commercial banks in the nation. This term is used by the Indian government. The word ‘statutory’ indicates that it is mandatorily and legally required. The Reserve Bank of India (RBI) Act states that every commercial bank in India has to keep a certain amount of time deposits as well as demand deposits as liquid assets in its independent and own vault.

In the case of statutory liquidity ratio, these assets can be gold, cash, securities that are approved by the Indian government, etc. Apart from these assets, securities that are sanctioned under market stabilisation schemes (MSS) as well as market borrowing programmes, and treasury bills are included in the statutory liquidity ratio. Every bank must maintain this particular SLR as it assists in the process of increasing bank credit.

SLR is one of the reserve ratios that has to be maintained by all banks as per the mandate of RBI. The other reserve ratio is known as the cash reserve ratio (CRR). A CRR refers to a particular percentage of a bank’s overall deposits that needs to be kept with the Reserve Bank of India as a cash reserve.

A bank needs to maintain both CRR and SLR in order to function effectively in India according to the specifications of the RBI. Each banking institution is given customised instructions regarding the maintenance of SLR by the RBI. The RBI also offers regular updates regarding the classification of assets that will be treated as liquid assets under SLR.

LAF

A liquidity adjustment facility (LAF) is a tool used in monetary policy, mainly by the Reserve Bank of India (RBI), which enables banks to borrow money through repurchase agreements (reposals) or banks to lend to the RBI using reverse repo contracts.

This arrangement manages liquidity pressures and ensures basic financial-market stability. The Reserve Bank of India transacts repositories and reverse repos within its open market operations in India.

Facilities for liquidity adjustment are used to help banks overcome any short-term cash shortages during periods of economic uncertainty or any other stress caused by circumstances beyond their control. Different banks use eligible securities as collateral through a repo agreement and utilize the funds to ease their short-term requirements, thus remaining constant.

The facilities are introduced on a daily basis as banks and other financial institutions make sure they have sufficient capital on the overnight market.

The transaction of liquidity adjustment facilities takes place at a set time of the day, through an auction. A company that wants to raise capital to accomplish a shortfall is engaged in repo agreements, while one with excess capital is doing the opposite – executing a reverse repo agreement.

The RBI may use the facility for adjusting liquidity to manage high levels of inflation. It does this by raising the repo rate, which increases the cost of debt servicing. This, in turn, reduces the supply of investment and money within the economy of India.

Alternatively, if the RBI tries to boost the economy after a period of slow economic growth, the repo rate can be lowered to encourage businesses to borrow, thus increasing the supply of money.

For instance, analysts predict RBI to cut the repo rate in April 2019 by 25 basis points due to weak economic activity, low inflation, and slower global growth. However, as growth accelerates and inflation picks up, analysts expect repo rates to resume rising by 2020.