Brief on Repo, Reverse Repo, CRR and SLR
You must have heard these terms a lot but never got to know what actually are these and what are these used for. In this article we have covered most common and important banking terms.
Cash Reserve Ratio (CRR)
- Cash reserve Ratio (CRR) is the amount of funds that the banks are required to park/keep with the RBI. If the central bank (RBI) decides to increase the CRR, the available amount with the banks comes down. The RBI resorts to CRR tool to drain out excess money out of the system.
- Commercial banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 3% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly basis and the RBI is empowered to increase the rate of CRR to such higher rate not exceeding 20% of the NDTL.
- Consider that a bank’s total deposit amount is Rs. 100 crore. If RBI says that the CRR is 3%, then that bank must keep Rs. 3 crore with the RBI has liquid money. Now, the bank can give only 97% of their total deposits as loans to customers i.e Rs. 97 crores.
- The rate at which the RBI lends money to commercial banks (this is precisely why a central bank is called the banker’s bank) is called repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI. A reduction in the repo rate helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US.
- Discount rate is at which a central bank repurchases government securities from the commercial banks, depending on the level of money supply it decides to maintain in the country’s monetary system. To temporarily expand the money supply, the central bank decreases repo rates (so that banks can swap their holdings of government securities for cash), to contract the money supply it increases the repo rates. Alternatively, the central bank decides on a desired level of money supply and lets the market determine the appropriate repo rate.
- When Repo rates are increased, the borrowing rate is expensive thus dissuading banks from taking loans from the RBI. This reflects into the economy with less amount of money given for lending and higher interest rates.
Reverse Repo rate
- Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money is in safe hands with a good interest.
- An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash.
- It is also a tool which can be used by the RBI to drain excess liquidity (money) out of the banking system.
Statutory Liquidity Ratio (SLR)
- SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form of cash, or gold or government approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit.
- SLR is determined as the percentage of total demand and percentage of time liabilities. Time Liabilities are the liabilities a commercial bank liable to pay to the customers on their anytime demand.
- With the SLR (Statutory Liquidity Ratio), the RBI can ensure the solvency a commercial bank. It is also helpful to control the expansion of Bank Credits. By changing the SLR rates, RBI can increase or decrease bank credit expansion. Also through SLR, RBI compels the commercial banks to invest in government securities like government bonds.
- SLR to Control Inflation and propel growth – SLR is used to control inflation and propel growth. Through SLR rate tuning the money supply in the system can be controlled efficiently.
Now I am sure that next time when you read or listen any of these term you will fairly know what it means.