Central Bank Monetary Policies: Adjusting CRR and SLR to Combat Inflation

In times of inflation, central banks often employ a variety of monetary policies to reign in rising prices. Two key measures that central banks commonly use are the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR). These policies are designed to reduce the amount of money circulating in the economy, thereby curbing inflationary pressures.

Cash Reserve Ratio (CRR)

The Cash Reserve Ratio (CRR) is the percentage of a bank's total deposits that must be kept as reserves with the central bank. By increasing the CRR, the central bank effectively reduces the amount of money available for lending. This decrease in the money supply can help to control inflation. When the RBI increases the CRR, banks have less cash to lend out, which means they can only accommodate fewer loan applications. Consequently, this leads to a higher cost of borrowing, as banks try to maintain their profit margins by increasing lending rates. As a result, consumers are discouraged from borrowing, spending, and, ultimately, driving up inflation.

CRR and the RBI Act 1934: According to Section 421 of the RBI Act 1934, Scheduled Commercial Banks must maintain with the RBI an average cash balance not less than 3% and not exceeding 20% of the total of their Net Demand and Time Liabilities (NDTL).

Statutory Liquidity Ratio (SLR)

The Statutory Liquidity Ratio (SLR) is the minimum percentage of a bank's net demand and time liabilities that must be maintained in the form of liquid assets such as cash, gold, or government securities. By increasing the SLR, the central bank forces banks to hold more liquid assets, which limits their ability to lend and reduces overall liquidity in the market. This can help curb inflation by reducing the amount of money available for consumer and business spending. When the RBI increases the SLR, banks are compelled to lower their lending rates for borrowed funds from the central bank. This, in turn, leads to an increase in interest rates for customers, which reduces borrowing and spending, leading to a decrease in demand for goods and services and, consequently, a reduction in prices.

SLR and Monetary Policy: By changing the SLR rates, the RBI can control the expansion of bank credit. Higher SLR rates decrease the liquidity available for lending, while lower rates increase it. The RBI is also able to compel banks to invest in government securities, thereby ensuring that the money supply remains under control.

Monetary Policy Instruments: Repo Rates and Reverse Repo Rates

Central banks also use other monetary policy instruments such as the Repo Rate and Reverse Repo Rate. The Repo Rate is the rate at which commercial banks can borrow funds from the RBI. Increasing the Repo Rate makes borrowing more expensive, which encourages banks to hold more reserves and lends less. Similarly, the Reverse Repo Rate is the rate at which the RBI borrows funds from commercial banks. Increasing this rate makes it more attractive for banks to lend to the RBI, reducing liquidity in the market.

Conclusion

Central banks use a combination of CRR, SLR, Repo Rate, and Reverse Repo Rate to manage inflation and promote economic stability. To curb inflation, the RBI can increase the CRR and SLR, making lending more expensive and reducing the liquidity in the market. Conversely, to stimulate growth, the RBI can reduce these rates, making borrowing cheaper and increasing liquidity. By carefully managing these monetary policies, the RBI can maintain a healthy balance in the economy and ensure that inflation remains under control.