Statutory Liquidity Ratio (SLR) & Cash Reserve Ratio (CRR) - Introduction

There are in the nature lifeline and protective insulators for a commercial bank. Like any other commercial enterprise, a banking institution strives to maximise its profit and that of its shareholders wealth. Ensuring profitability should be the logical and normal objective.

But the financial structure of a commercial bank is different from that of other corporate organizations. The shareholders contribute a very small percentage of its resources (sometime as little as 5% or even less) and the bulk of the funds that a bank uses for its business are from the public i.e. depositors. The business of the bank is that of accepting deposits from the public and utilizing the same for investment or for extending credit to business and industry. Depositors entrust their money with the bank based on the implicit faith and confidence in its solvency and credit worthiness. The success and endurance of the bank depends therefore on the continued business support from the customers, which in turn depends on the reputation and good credit it enjoys in the market. The customer feels that the money deposited with the bank is totally safe. This correspondingly enjoins on the bank to take every care and control in safeguarding the security of the customers funds entrusted to him. Therefore for a banker the security of customers' funds ranks at par with his objective to earn profits for the shareholders. The profits cannot be earned jeopardizing the security of the funds of the depositors. On the face these two objectives of 1.profitability and 2.security are mutually conflicting. Profitability necessitates risk-taking, while security forbids such risk-taking. So what is the alternative? Bankers out of the wisdom gained in their business over years have found ways of reconciling the mutually conflicting objectives by inclusion of two more business regulations. These are liquidity and spread. (Spread to a banker is like bread to the ordinary man)

On the one hand the bank should ever be ready to repay the customer's money, whenever demanded by him or whenever it matures for payment based on the nature of the deposit. Liabilities can therefore accrue to the bank to be discharged perennially. On the other hand the assets of the bank are prone to normal risk in the business and may deteriorate or even partly lost. If the bank has Rs.10000 as capital and Rs.90000 as deposits, its total resources are then Rs.100000. It will have therefore assets worth Rs.100000. If the assets depreciate and reduce in value to Rs.95, 000/-, as against its worth of Rs.100000 originally, its capital will be reduced to Rs.5000 i.e. 50% of its capital is wiped out. This is precarious fact that a banker should realize. He cannot afford to lose, more than the profits earned by him. The two business objectives of the bank are therefore:

1. It must always hold ready means to discharge its obligations to the depositors at all times. This is secured by the principle of "Liquidity."

2. It must protect its assets and take all safeguards to mitigate risk to the minimum. This is secured by the principle of "Spread."

By means of the principle of liquidity banks distributes the assets in different time buckets, so that these mature (get repaid) and becomes available to him in cash in a circulatory flow. The spreads here as is as under:

1. Keep a portion in cash or with RBI or its agents.

2. Adequate portion in gilt securities that can be quickly converted into cash.

3. Some portion in inter-bank call money market.

4. As a next line of defence advance to business by discounting demand trade bills or acceptance bills very of short tenure. Advance against Receivables. These are realizable in cash generally within a fortnight or month's time.

5. Lend mainly short term and accept as security only items that are quickly saleable.

6. Primarily lend to working capital, where the capital is circulated yielding ready cash flow.

Item No.1 and 2 are the principles pillars that provide security. The Banking Regulations Act, 1949 has given powers to the RBI, the Central Bank of the country to decide and direct the banks to hold cash balance and investment in approved securities as per percentage to be decided and directed by it from time to time. Presently RBI has directed that Banks must maintain 4.5% of CRR and 25% of SLR in relations to its total demand and time liabilities. Every branch of a commercial bank prepares a statement of its Assets & Liabilities as at the close of every Friday and submits the same to its head office. These are consolidated by the head office and submitted in turn to RBI. From this statement RBI could find in respect of each bank as at every Friday-

1. Its total of liabilities.

2. Its holding of balance in cash and with RBI. CRR can be calculated from this based on the proportion of 2 to 1.

3. Its investment in Government securities. SLR is also calculated on the basis of relationship of 3 to 1.

Whenever a bank violates the norms of CRR or SLR on any Friday RBI imposes on the violator a hefty penalty by way of fine. If the default takes place regularly or continuously RBI may take a serious view. It may even cancel the licence of the bank. It may declare a moratorium and merge the bank with a bigger entity. It is known that particular banks in the 80's were forced to borrow heavily on a day-to-day basis from the Inter-bank Call Money market at 25% p.a. and above merely to comply with CRR/SLR requirements.

The other concept of spread is a tool to mitigate risk. It is based on the dictum that when you large number of eggs do not keep them all in one basket. Thus a bank having resources of Rs.100 Crore will not like to lend it only 10 big borrowers at Rs.10 Crore each. It will spread its credit. The word used here is "portfolio" which means collection to larger number of customers. It may not give more than Rs.1 Crore maximum to a single borrower or to a group. (However RBI has permitted upto 5% maximum ceiling for a single borrower). The principle of spread is also chosen between different industries and different geographical centres etc.

Operational Guidelines by RBI updated as at August 05, 2004 and covered by Master Circular of that date is given in the next page.