1

DR. RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY

2015-16
FINAL DRAFT
BANKING LAW

Monetory Policy of India :

Cash Reserve Ratio and Statutory Liquidity Ratio

Under Guidance of Submitted by

Dr. Aparna Singh Yagya Srivastava
Assistant Professor (Law) Roll Number : 155
Dr. RML National Law University, Semester V
Lucknow.
 2

Acknowledgement

I express my gratitude and deep regards to my teacher for the subject Dr. Aparna Singh for
giving me such a challenging topic and also for her exemplary guidance, monitoring and
constant encouragement throughout the course of this thesis.

I also take this opportunity to express a deep sense of gratitude to my seniors in the college
for their cordial support, valuable information and guidance, which helped me in completing
this task through various stages.

I am obliged to the staff members of the Madhu Limaye Library, for the timely and valuable
information provided by them in their respective fields. I am grateful for their cooperation
during the period of my assignment.

Lastly, I thank almighty, my family and friends for their constant encouragement without
which this assignment would not have been possible.
 3

INDEX

1. Introduction………………………………………………..…………….(4)
2. Monetory Policy in India : Meaning and Objectives………...…………..(5)
3. Objectives of Monetory Policy of India……………………...……….….(6)
4. Methods of Credit Control of Reserve Bank of India.……......………….(8)
 Quantitative
 Qualitative
5. CRR and SLR : Meaning and application……………………..………..(13)
6. Changing role of CRR…………………………………………..………(13)
 Role in controlling inflation
7. SLR a cushion for safety……………………………………………..…(15)
 Narsimham Committee Report
 Value and formula of calculation
8. Manipulating CRR and SLR to exit crisis………………………………(16)
9. Suggestive inputs……………………………………………………..…(20)
10.Conclusion………………………………………………………………(20)
 4

Introduction

The world has reached the era where the strength of a country is determined by value of their
economy. Nowdays, in this era, the economic indices are much more relevant than the number
of army personnel, the post of the chief economic advisor and the Reserve Bank of India
governor is much more valued than that of the chief of the armed forces. The whole world
watches the economic growth of each country, friendly countries in order to invest and enemy
out of envy. This makes the work of the central bank, Reserve Bank of India (RBI) here, full of
expectations. In India, monetary policy of the Reserve Bank of India is aimed at managing the
quantity of money in order to meet the requirements of different sectors of the economy and to
increase the pace of economic growth. The Reserve Bank of India implements the monetary
policy through either quantitative measures of credit control such as open market operations,
bank rate, reserve system, credit control policy or by qualitative measures of credit control such
as margin, consumer credit regulation, moral persuasion and through many other instruments.

The use of such qualitative and quantitative measures should be done wisely after a lot of
deliberation to as to increase its effectiveness and efficiency. Using any of these instruments
will lead to changes in the interest rate, or the money supply in the economy. Monetary policy
can be both expansionary and contractionary in nature. Decisions which could lead to an
increased amount of money supply in the market such as that of reducing interest rates indicate
an expansionary policy. The reverse of this is the contractionary monetary policy. Take for
instance, a decision of an increased Chash Reserve Ration (CRR), shall lead to lesser uantum
of cash flow in the market an another instance could be that of a decision of purchasing bonds
through open market operations, the Reserve Bank of India introduces money in the system
and reduces the interest rate. The Reserve Bank of India by planned and strategic use of
determining the Cash Reserve Ratio(CRR) and the Statutory Liquidity Ratio(SLR) exercises
quantitative control over credit in India.

A lot shall be needed to understand what goes behind when deciding the Cash Reserve Ratio
and Statutory Liquidity Ratio and its effect on the market and also how it is related to inflation.
Conrolling these indices are not as easy as they look, a lot of deliberation goes behind the
decision. One wrong assessment of the market could lead to a huge financial crisis, which
could also impact internationally in this age of globalisation and inegration of the world
economies.
 5

Monetory Policy in India : Meaning and Objectives

Monetary policy is the macroeconomic policy laid down by the central bank. It involves
management of money supply and interest rate and is the demand side economic policy used
by the government of a country to achieve macroeconomic objectives like inflation,
consumption, growth and liquidity1. Monetary policy is concerned with the measures taken to
regulate the supply of money, the cost and availability of credit in the economy. Further, it also
deals with the distribution of credit between uses and users and also with both the lending and
borrowing rates of interest of the banks. In developed countries the monetary policy has been
usefully used for overcoming depression and inflation as an anti-cyclical policy. However, in
developing countries such as India, it has to play a significant role in promoting economic
growth. As Prof. R. Prebisch writes, “The time has come to formulate a monetary policy which
meets the requirements of economic development, which fits into its framework perfectly.2”
Further, along with encouraging economic growth, the monetary policy has also to ensure price
stability, because the excessive inflation not only has adverse distribution effect but hinders
economic development also.

It is important to understand the distinction between objectives or goals, targets and instru-
ments of monetary policy. Whereas goals of monetary policy refer to its objectives which, as
mentioned above, may be price stability, full employment or economic growth, targets refer to
the variables such as supply of money or bank credit, interest rates which are sought to be
changed through the instruments of monetary policy so as to attain these objectives. The
various instruments of monetary policy that have been discussed in this paper are changes in
the supply of currency, variations in bank rates and other interest rates, open market operations,
selective credit controls, and variations in reserve requirements.

Objectives of Monetary Policy

Before explaining in detail the monetary measures undertaken by RBI to regulate credit and
growth of money supply, it is important to understand the objectives of monetary policy

1
RNChaudhary, Banking Laws(3rd edn, Central Law Publications 2015) 447.
2
Supriya Guru, ‘Meaning and Objectives of Economic Policy’ 2014, article library <
http://www.yourarticlelibrary.com/economics/the-meaning-and-objectives-of-monetary-policy/37889/ >
accessed 1 Oct 2015.
 6

pursued of RBI in formulation of its policy. Since monetary policy is one instrument of
economic policy, its objectives cannot be different from those of overall economic policy.

a) Ensuring price stability, that is, containing inflation

Each instrument of economic policy is better suited to achieve a particular objective. Monetary
policy is better suited to the achievement of price stability that is, containing inflation. To
quote C. Rangarajan, a former Governor of Reserve Bank of India. “Faced with multiple
objectives that are equally relevant and desirable, there is always the problem of assigning to
each instrument the most appropriate target or objective. Of the various objectives, price
stability is perhaps the one that can be pursued most effectively by monetary policy. In a
developing country like ours, acceleration of investment activity in the context of supply
shocks in the agricultural sector tends to be accompanied by pressures on prices and, therefore,
monetary policy has much to contribute in the short-run management.3” Thus, achieving price
stability has remained the dominant objective of monetary policy of Reserve Bank of India. It
may however be noted that price stability does not mean absolutely no change in price at all. In
a developing economy like ours where structural changes take place during the process of
economic growth some changes in relative prices do occur that generally put upward pressure
on prices. Therefore, some changes in price level or, in other words, a certain rate of inflation
is inevitable in a developing economy.

Thus, price stability means reasonable rate of inflation. A high degree of inflation has adverse
effects on the economy. First, inflation raises the cost of living of the people and hurts the poor
most. Therefore, inflation has been described as the worst enemy of the poor. Inflation sends
many people below the poverty line. Secondly, inflation makes exports costlier and, therefore,
discourages them. On the other hand, due to higher prices at home people are induced to import
goods to a large extent. Thus, inflation has an adverse effect on the balance of payments.
Thirdly, when due to a higher rate of inflation value of money is rapidly falling, people do not
have much incentive to save. This lowers the rate of saving on which investment and economic
growth depend. Fourthly, a high rate of inflation encourages businessmen to invest in the
productive assets such as gold, jewellery, real estate etc. An expert committee on monetary
reforms headed by Late Prof. S. Chakravarty suggested 4 per cent rate of inflation as a

3
Ibid.
 7

reasonable rate of inflation and recommended that monetary policy by RBI should be so
formulated that ensures that rate of inflation does not exceed 4 per cent per annum.

b) To encourage economic growth

Promoting economic growth is another important objective of the monetary policy. In the past
Reserve Bank has been criticised that it pursued the objective of achieving price stability and
neglected the objective of promoting economic growth. Monetary policy can promote
economic growth through ensuring adequate availability of credit and lower cost of credit.
There are two types of credit requirements of businesses. First, they have to finance their
requirements of working capital and for importing needed raw materials and machines from
broad. Secondly, they need credit for financing investment in projects for building fixed
capital. Easy availability of credit at low interest rate stimulates investment and thereby
quickens economic growth. However, during the seventies, eighties and the first half of
nineties, Reserve Bank followed a tight monetary policy under which Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR) were continually raised to restrict the availability
of credit for private sector. Besides, lending rates of interest were kept at high levels which
discouraged private investment. This tight monetary policy worked against promoting growth.
But large expansion in money supply and bank credit leads to the increase in aggregate demand
which tends to cause a higher rate of inflation. This raises the issue of what is acceptable
tradeoff between growth and inflation, that is, what rate of inflation is acceptable to promote
growth through appropriate monetary policy. Expert Committee on monetary policy headed by
Late Prof. Chakravarty suggested a target of 4 per cent as “the acceptable rise in prices”.

c) Exchange Rate Stability

Until 1991, India followed fixed exchange rate system and only occasionally devalued the
rupee with the permission of IMF. The policies of floating exchange rate and increasing
openness and globalisation of the Indian economy, adopted since 1991 have made the
exchange rate of rupee quite volatile. The changes in capital inflows and capital outflows and
changes in demand for and supply of foreign exchange, particularly US dollar, arising from the
imports and exports cause great fluctuations in the foreign exchange rate of rupee.

In order to prevent large depreciation and appreciation of foreign exchange rate Reserve Bank
has to take suitable monetary measures to ensure foreign exchange rate stability. Owing to the
 8

fixed exchange rate system prior to 1991 the concern about foreign exchange rate had not
played a significant role in the formulation of monetary policy. Today, the exchange rate of
rupee is determined by demand for and supply of foreign exchange. When there is mismatch
between demand for and supply of foreign exchange, external value of rupee changes.

Thus, through rise in the cost of credit and reduction in the availability of credit, borrowing
from the banks were discouraged which was expected to reduce the demand for dollars. The
higher interest rates in India would also discourage foreign institutional investors and Indian
corporate to invest abroad. This will also work to reduce the demand for dollars which will
prevent the fall in the value of the rupee. Alternatively, to prevent the depreciation of the rupee,
Reserve Bank can release more dollars from its foreign exchange reserves. The release of more
dollars by Reserve Bank will increase the supply of US dollars in the foreign exchange market
and will therefore tend to correct the mismatch between demand for and supply of the US
dollars. This will help in stabilising the exchange rate of the rupee. It is clear from above that in
the context of flexible exchange rate system, Reserve Bank has to intervene frequently to
achieve stability of exchange rate at a reasonable level.

Methods of Credit Control by Reserve Bank of India

Credit Control is an important tool used by Reserve Bank of India, a major weapon of the monetary
policy used to control the demand and supply of money (liquidity) in the economy. Central Bank
administers control over the credit that the commercial banks grant.

Such a method is used by RBI to bring “Economic Development with Stability”. It means that banks
will not only control inflationary trends in the economy but also boost economic growth which would
ultimately lead to increase in real national income with stability. In view of its functions such as issuing
notes and custodian of cash reserves, credit not being controlled by RBI would lead to Social and
Economic instability in the country.

Methods of Credit Control

There are two methods that the RBI uses to control the money supply in the economy, namely
the qualitative and quantitative method.
 9

During the period of inflation Reserve Bank of India tightens its policies to restrict the money
supply, whereas during deflation it allows the commercial bank to pump money in
the economy. The various methods employed by the RBI to control credit creation power of
the commercial banks can be classified in two groups, viz., quantitative controls and qualitative
controls. Quantitative controls are designed to regulate the volume of credit created by the
banking system qualitative measures or selective methods are designed to regulate the flow of
credit in specific uses. Quantitative or traditional methods of credit control include banks rate
policy, open market operations and variable reserve ratio. Qualitative or selective methods of
credit control include regulation of margin requirement, credit rationing, regulation of
consumer credit and direct action.

Quantitative Method:

a) Bank Rate:

The bank rate, also known as the discount rate, is the rate payable by commercial banks on the
loans from or rediscounts of the Central Bank. A change in bank rate affects other market rates
of interest. An increase in bank rate leads to an increase in other rates of interest and
conversely, a decrease in bank rate results in a fall in other rates of interest. A deliberate
manipulation of the bank rate by the Central Bank to influence the flow of credit created by the
commercial banks is known as bank rate policy. It does so by affecting the demand for credit
the cost of the credit and the availability of the credit. An increase in bank rate results in an
increase in the cost of credit; this is expected to lead to a contraction in demand for credit. In as
much as bank credit is an important component of aggregate money supply in the economy, a
contraction in demand for credit consequent on an increase in the cost of credit restricts the
total availability of money in the economy, and hence may prove an anti-inflationary measure
of control.

b) Open Market Operations:

Open market operations refer to the sale and purchase of securities by the Central bank to the
commercial banks. A sale of securities by the Central Bank, i.e., the purchase of securities by
the commercial banks, results in a fall in the total cash reserves of the latter. A fall in the total
cash reserves is leads to a cut in the credit creation power of the commercial banks. With
reduced cash reserves at their command the commercial banks can only create lower volume of
 10

credit. Thus, a sale of securities by the Central Bank serves as an anti-inflationary measure of
control. Likewise, a purchase of securities by the Central Bank results in more cash flowing to
the commercials banks. With increased cash in their hands, the commercial banks can create
more credit, and make more finance available. Thus, purchase of securities may work as an
anti-deflationary measure of control.

c) Variable Reserve Ratios:

Variable reserve ratios refer to that proportion of bank deposits that the commercial banks are
required to keep in the form of cash to ensure liquidity for the credit created by them. A rise in
the cash reserve ratio results in a fall in the value of the deposit multiplier. Conversely, a fall in
the cash reserve ratio leads to a rise in the value of the deposit multiplier. A fall in the value of
deposit multiplier amounts to a contraction in the availability of credit, and, thus, it may serve
as an anti-inflationary measure. A rise in the value of deposit multiplier, on the other hand,
amounts to the fact that the commercial banks can create more credit, and make available more
finance for consumption and investment expenditure. A fall in the reserve ratios may, thus,
work as anti-deflationary method of monetary control.

The Reserve Bank of India is empowered 4 to change the reserve requirements of the
commercial banks. The Reserve Bank employs two types of reserve ratio for this purpose, viz.
the Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR).

Statutory liquidity ratio (SLR) is the Indian government term for reserve requirement that
the commercial banks in India require to maintain in the form of gold, government
approved securities before providing credit to the customers. Statutory Liquidity Ratio is
determined and maintained by Reserve Bank of India in order to control the expansion of bank
credit. The SLR is determined by a percentage of total demand and time liabilities. Time
Liabilities refer to the liabilities which the commercial banks are liable to pay to the customers
after a certain period mutually agreed upon, and demand liabilities are such deposits of the
customers which are payable on demand. An example of time liability is a six month fixed
deposit which is not payable on demand but only after six months. An example of demand
liability is a deposit maintained in saving account or current account that is payable on demand
through a withdrawal form such as a cheque.

4
under section
 11

The SLR is commonly used to control inflation and fuel growth, by increasing or decreasing it
respectively. This counter acts by decreasing or increasing the money supply in the system
respectively. Indian banks’ holdings of government securities are now close to the statutory
minimum that banks are required to hold to comply with existing regulation. When measured
in rupees, such holdings decreased for the first time in a little less than 40 years (since the
nationalisation of banks in 1969) in 2005–06.currently it is 21.5 percent as on 15 September
2015.

SLR is used by bankers and indicates the minimum percentage of deposits that the bank has to
maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of
cash and some other approved liability (deposits). It regulates the credit growth in India. The
liabilities that the banks are liable to pay within one month's time, due to completion of
maturity period, are also considered as time liabilities. The maximum limit of SLR is 40% and
minimum limit of SLR is 0 In India, Reserve Bank of India always determines the percentage
of SLR. There are some statutory requirements for temporarily placing the money in
government bonds. Following this requirement, Reserve Bank of India fixes the level of SLR.
At present, the minimum limit of SLR that can be set by the Reserve Bank is
21.5%5. However, as most banks currently keep an SLR higher than required (>26%) due to
lack of credible lending options, near term reductions are unlikely to increase liquidity and are
more symbolic.

The main objectives for maintaining the SLR ratio are the following:

 to control the expansion of bank credit. By changing the level of SLR, the Reserve Bank
of India can increase or decrease bank credit expansion.
 to ensure the solvency of commercial banks.
 to compel the commercial banks to invest in government securities like government
bonds.

If any Indian bank fails to maintain the required level of Statutory Liquidity Ratio, then it
becomes liable to pay penalty to Reserve Bank of India. The defaulter bank pays penal
interest at the rate of 3% per annum above the Bank Rate, on the shortfall amount for that
particular day. But, according to the Circular, released by the Department of Banking
Operations and Development, Reserve Bank of India; if the defaulter bank continues to default
on the next working day, then the rate of penal interest can be increased to 5% per annum
5
AS ON 3 Feb 2015
 12

above the Bank Rate. This restriction is imposed by RBI on banks to make funds available to
customers on demand as soon as possible. Gold and government securities (or gilts) are
included along with cash because they are highly liquid and safe assets. The RBI can increase
the SLR to control inflation, suck liquidity in the market, to tighten the measure to safeguard
the customers money. In a growing economy banks would like to invest in stock market, not in
government securities or gold as the latter would yield less returns. One more reason is long
term government securities (or any bond) are sensitive to interest rate changes. But in an
emerging economy interest rate change is a common activity.

Cash Reserve Ratio (CRR) is the amount of funds that all Scheduled Commercial Banks
(SCB) excluding Regional Rural Banks (RRB) are required to maintain without any floor or
ceiling rate with RBI with reference to their total net Demand and Time Liabilities (DTL) to
ensure the liquidity and solvency of Banks6.

In terms of Section 42(1)7, Scheduled Commercial Banks are required to maintain with RBI an
average cash balance, the amount of which shall not be less than 3% and higher rate not
exceeding 20% of the total of the Net Demand and Time Liabilities (NDTL) in India.

Qualitative Method:
The qualitative or selective methods of credit control are adopted by the Central Bank in its
pursuit of economic stabilisation and as part of credit management.

a) Margin Requirements:
Changes in margin requirements are designed to influence the flow of credit against specific
commodities. The commercial banks generally advance loans to their customers against some
security or securities offered by the borrower and acceptable to banks. More generally, the
commercial banks do not lend up to the full amount of the security but lend an amount less
than its value. The margin requirements against specific securities are determined by the
Central Bank. A change in margin requirements will influence the flow of credit. A rise in the
margin requirement results in a contraction in the borrowing value of the security and
similarly, a fall in the margin requirement results in expansion in the borrowing value of the
security.

6
Reserve Bank of India Act 1934, s 42(1).
7
Ibid.
 13

b) Credit Rationing:

Rationing of credit is a method by which the Central Bank seeks to limit the maximum amount
of loans and advances and, also in certain cases, fix ceiling for specific categories of loans and
advances.

c) Regulation of Consumer Credit:

Regulation of consumer credit is designed to check the flow of credit for consumer durable
goods. This can be done by regulating the total volume of credit that may be extended for
purchasing specific durable goods and regulating the number of installments through which
such loan can be spread. Central Bank uses this method to restrict or liberalise loan conditions
accordingly to stabilise the economy.

d) Moral Suasion:

Moral suasion and credit monitoring arrangement are other methods of credit control. The
policy of moral suasion will succeed only if the Central Bank is strong enough to influence the
commercial banks.

In India, from 1949 onwards, the Reserve Bank has been successful in using the method of
moral suasion to bring the commercial banks to fall in line with its policies regarding credit.
Publicity is another method, whereby the Reserve Bank marks direct appeal to the public and
publishes data which will have sobering effect on other banks and the commercial circles.

Changing role of Cash Reserve Ratio

The CRR is partly a prudential requirement for banks to maintain a minimum amount of cash
reserves to meet their payments obligations in a fractional reserve system. The Reserve Bank
of India (RBI) Act implicitly prescribed the CRR originally at a minimum of 3 per cent of any
bank’s net demand and time liabilities. That restriction was removed by an amendment in
2006. While the RBI is now free to prescribe this rate, any CRR above 3 per cent can still be
viewed as a monetary tool to contain expansion of money supply by influencing the money
multiplier. But the way in which the CRR was operated historically made it serve a much wider
 14

role. During the 1990s, when there was influx of foreign funds through non-resident Indian
(NRI) deposits, a differential CRR was prescribed on such deposits to restrict their inflows.8

This role — CRR being used as an instrument of regulating NRI deposit flows — got relegated
to the background once the relative attraction of such deposits vis-a-vis rupee deposits was
removed. Now that the interest rates on NRI deposits have been freed, the above role of CRR
could well be revived again. In the more recent period after 2004, when there was a huge influx
of foreign capital through varied forms of debt and non-debt flows, and the RBI ended up
accumulating large forex reserves, the CRR became an optional instrument to sterilise the
rupee resources released from such dollar purchases. This was particularly enabled by not
paying any interest on CRR balances maintained by banks with the RBI. The other options of
sterilisation through open market operations and the repo operations through the liquidity
adjustment window (LAF) cost the central bank, just as the market stabilisation scheme cost
the Government fiscally in terms of interest payments.

The official view on CRR has been changing. During the period of financial repression before
1990s, CRR was the most preferred monetary policy tool. But the Narasimham Committee of
1991 recommended gradual reduction in CRR and increased use of indirect market-based
instruments. This was broadly accepted and the CRR reduced from more than 15 per cent to
4.5 per cent by 2003. But since 2004, the use of CRR as an instrument of sterilisation and also
a monetary tool has gained ground again. At the same time, the ratio stands now at 4.5 per
cent, the previous historic low. Under these circumstances, the official philosophy on CRR in
the current juncture is not known. Since CRR acts as a tax that increases their transaction costs,
banks in general would want its role to be restored to being a prudential minimum requirement
of not more than 3 per cent. And since quantitative easing has become a fashion of central
banking across the world, the RBI may well choose to bring the CRR further down gradually to
about 3 per cent during the current easing phase, without losing sight of monetary control in
the face of inflation remaining stubbornly high at around 8 per cent.

Like CRR, SLR can also be viewed as a hybrid instrument of a different variety. The SLR,
according to some, is not a monetary tool and is only a prudential requirement to serve as a
cushion for safety of bank deposits. The minimum prescription in this manner was 25 per cent
of bank’s demand and time liabilities. But it was also more a way of finding a captive market

8
RNChaudhary, Banking Laws(3rd edn, Central Law Publications 2015) 432.
 15

for government securities, particularly when they were bearing below market interest rates. Not
surprisingly, this ratio touched about 38 per cent around 1991.

Cash Reserve Ration in controlling inflation

Lower CRR means bank can give more money as loan which means lower interest rates that
leads to cheap loan and more people take loan to start business or building house or buying car
and therefore boost the economy. However, can also lead to inflation, if people have more cash
in their hands than the items available for purchase in the market. Higher CRR means banks
can give less money as loan and they will charge higher interest rate and therefore it becomes
expensive to start a new factory or buy a new house, car or bike. This can curb inflation but
may also lead to slowdown in economy, because people wait for the interest rates to go down,
before taking loans. With every cut in 25 basis points in CRR it would infuse the liquidity of
Rs.16000 crore. Whenever the RBI hikes the CRR rate, a lot of excess liquidity is sucked out
of the markets. Banks have lesser cash available with them to deploy as loans. Consequently,
to maintain their profit margins, they have to increase the lending rates at which they disburse
loans. As loan rates go up, consumers tend to borrow less and eventually spend less. Thus the
demand for goods and services goes down. All inflated prices start coming down due to the
decrease in demand. And as prices start moving downwards, inflation starts coming down.

Statutory Liquidity Ratio, a cushion for safety

For the SLR too, the Narasimham Committee’s view was to bring it down to 25 per cent and
resort to auctioning government securities at market related rates. Accordingly, the SLR was
reduced to 25 per cent by 1997. Just as for CRR, RBI now has the freedom to also fix the level
of SLR. The effective SLR, ironically though, never fell to 25 per cent at least for public sector
banks. These banks found investments in SLR securities as a safe haven to optimise their risk-
weighted capital adequacy requirements during late 1990s and the early 2000s. The
Government’s ever-increasing borrowings appetite also served this purpose well. It was only
between 2004 and 2008, as non-performing asset (NPA) levels fell and fiscal consolidation
 16

was also in place, that banks shifted their portfolio more in favour of credit rather than SLR
investments9.

The SLR now has, thus, regained its earlier status of being a tool for providing a captive
market for government securities. With the Government taking over the function of issuing
regulatory guidelines to public sector banks, in parallel with or even over-riding that of the
central bank, this role is bound to further strengthen. That, of course, is not a desirable trend at
all. It would be worth recalling the Narasimham Committee’s view that the ownership of banks
by the Government should not interfere with the conduct of banking regulation.

It must be a matter of great relief to the banking system that the RBI Deputy Governor, Anand
Sinha, has recently hinted that the SLR will be tweaked to accommodate the new Basel norms
on liquidity. This notably keeps the spirit behind SLR, that though it is statutorily prescribed, it
is mainly for the purpose of serving as a cushion to meet contingencies against potential
liquidity threats to banking operations.

Value Formula

The quantum of SLR is specified as some percentage of the total demand and time liabilities (
i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities which
are accruing in one months time due to maturity) of a bank.

SLR rate = (liquid assets / (demand + time liabilities)) × 100%

This percentage is fixed by the central bank. The maximum and minimum limits for the SLR
were40% and 25% respectively in India. Following the amendment of the Banking regulation
Act(1949) in January 2007, the floor rate of 25% for SLR was removed. Presently, the SLR is
21.5%.

Narsimham Committee Report

From the 1991 India economic crisis to its status of third largest economy in the world by
2011, India has grown significantly in terms of economic development. So has its banking
9
S. Subramanian, "Business houses can set up banks" (2006) The Economic Times 2011 <
http://articles.economictimes.indiatimes.com/2012-07-31/news/32961836_1_rbi-governor-duvvuri-subbarao-
policy-rates-repo-rate> accessed 03 Oct 2015.
 17

sector. During this period, recognising the evolving needs of the sector, the Finance Ministry
of Government of India (GOI) set up various committees with the task of analysing India's
banking sector and recommending legislation and regulations to make it more effective,
competitive and efficient.10 Two such expert Committees were set up under the chairmanship
of M. Narasimham. They submitted their recommendations in the 1990s in reports widely
known as the Narasimham Committee-I (1991) report and the Narasimham Committee-II
(1998) Report.

Narsimham Committee Report 1, 1991

The Narsimham Committee was set up in order to study the problems of the Indian financial
system and to suggest some recommendations for improvement in the efficienct and
productivity in the financial institution. The committee had given the following major
recommendations:-

1. Reduction in the SLR and CRR : The committee recommended the reduction of the higher
proportion of the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio 'CRR'. Both of
these ratios were very high at that time. The SLR then was 38.5% and CRR was 15%. This
high amount of SLR and CRR meant locking the bank resources for government uses. It was
hindrance in the productivity of the bank thus the committee recommended their gradual
reduction. SLR was recommended to reduce from 38.5% to 25% and CRR from 15% to 3 to
5%.

2. Phasing out Directed Credit Programme : In India, since nationalization, directed credit
programmes were adopted by the government. The committee recommended phasing out of
this programme. This programme compelled banks to earmark then financial resources for the
needy and poor sectors at confessional rates of interest. It was reducing the profitability of
banks and thus the committee recommended the stopping of this programme.

3. Interest Rate Determination : The committee felt that the interest rates in India are regulated
and controlled by the authorities. The determination of the interest rate should be on the

10
Gopal S, ‘Narasimham Committee report on the financial system,’ (1991) Standard Book Co.
<https://books.google.co.in/books?id=h5qaAAAAIAAJ&hl=en> accessed 03 October 2015.
 18

grounds of market forces such as the demand for and the supply of fund. Hence the committee
recommended eliminating government controls on interest rate and phasing out the
concessional interest rates for the priority sector.

4. Structural Reorganizations of the Banking sector : The committee recommended that the
actual numbers of public sector banks need to be reduced. Three to four big banks including
SBI should be developed as international banks. Eight to Ten Banks having nationwide
presence should concentrate on the national and universal banking services. Local banks
should concentrate on region specific banking. Regarding the RRBs (Regional Rural Banks), it
recommended that they should focus on agriculture and rural financing. They recommended
that the government should assure that henceforth there won't be any nationalization and
private and foreign banks should be allowed liberal entry in India.

5. Establishment of the ARF Tribunal : The proportion of bad debts and Non-performing asset
(NPA) of the public sector Banks and Development Financial Institute was very alarming in
those days. The committee recommended the establishment of an Asset Reconstruction Fund
(ARF). This fund will take over the proportion of the bad and doubtful debts from the banks
and financial institutes. It would help banks to get rid of bad debts.

6. Removal of Dual control : Those days banks were under the dual control of the Reserve
Bank of India (RBI) and the Banking Division of the Ministry of Finance (Government of
India). The committee recommended the stepping of this system. It considered and
recommended that the RBI should be the only main agency to regulate banking in India.

7. Banking Autonomy : The committee recommended that the public sector banks should be
free and autonomous. In order to pursue competitiveness and efficiency, banks must enjoy
autonomy so that they can reform the work culture and banking technology upgradation will
thus be easy.11

Some of these recommendations were later accepted by the Government of India and became
banking reforms.

Narsimham Committee Report 1, 1998

11
M. Narsimham, Committee Report on the Financial System(Standard Book Co. 1991) 204.
 19

In 1998 the government appointed yet another committee under the chairmanship of Mr.
Narsimham. It is better known as the Banking Sector Committee. It was told to review the
banking reform progress and design a programme for further strengthening the financial system
of India. The committee focused on various areas such as capital adequacy, bank mergers, bank
legislation, etc. Its recommendations were -

1. Strengthening Banks in India : The committee considered the stronger banking system in the
context of the Current Account Convertibility 'CAC'. It thought that Indian banks must be
capable of handling problems regarding domestic liquidity and exchange rate management in
the light of CAC. Thus, it recommended the merger of strong banks which will have 'multiplier
effect' on the industry.

2. Narrow Banking : Those days many public sector banks were facing a problem of the Non-
performing assets (NPAs). Some of them had NPAs were as high as 20 percent of their assets.
Thus for successful rehabilitation of these banks it recommended 'Narrow Banking Concept'
where weak banks will be allowed to place their funds only in short term and risk free assets.

3. Capital Adequacy Ratio : In order to improve the inherent strength of the Indian banking
system the committee recommended that the Government should raise the prescribed capital
adequacy norms. This will further improve their absorption capacity also. Currently the capital
adequacy ration for Indian banks is at 9 percent.

4. Bank ownership : As it had earlier mentioned the freedom for banks in its working and bank
autonomy, it felt that the government control over the banks in the form of management and
ownership and bank autonomy does not go hand in hand and thus it recommended a review of
functions of boards and enabled them to adopt professional corporate strategy.

5. Review of banking laws of Acts such as RBI Act, Banking Regulation Act, State Bank of
India Act, Bank Nationalisation Act, etc.

6. Apart from these major recommendations, the committee has also recommended faster
computerization, technology upgradation, training of staff, depoliticizing of banks,
professionalism in banking, reviewing bank recruitment, etc12.

12
Bank recruitment (n 10).
 20

Suggestive Inputs

India is a developing nation, and therefore I would like to back the Narsimham Committee
report with suggested lower levels of cash reserve ratio and statutory liquidity ratio. This shall
enable inflow of cash into the economy and further credit to potential debtors. This shall start a
domino effect which shall let the debtors invest, due to their new found cash reserve in form of
loans. Hence, a trader who used to sell 100 kg of goods will now sell 120kg for which he shall
employ more, if he employs more, the consumption will increase and therefore the growth
shall percolate even to the poorest eventually.

Further, another suggestion would that be of a liitle tweaking made to cash reserve ration
which is the amount of cash kept as reserve with the banks themselves to meet unknown
contigencies. This defintition should be amended so that banks can along with cash also keep
other securities which are easily convertible. Though there cannot be anythings as liquid as as
cash but then the circumstances prevailing in India are such that more and more money is
needed in the economy to facilitate development. These items of high liquidity could be that of
bonds, money market funds and mutual funds.

Conclusion
In the present scheme of things the Reserve Bank of India is doing a commendable job by
holding on to the string, which makes sure that there is enough cash in the bank to meet
contingencies and also there is enough to keep the investments ringing. Further the suggestive
inputs if ratified could facilitate further investments. India as a country needs investment in
volume as the infrastructure needs to be developed which is capital intensive. The importance
of Cash Reserve Ratio and Statutory Liquidity Ratio lies in the fact that both are immediately
implemented and one can see instant effect in the economy. Moral backing and margin
requirement are time consuming. Therefore cash reserve ratio and statutory liquidity ration
form the basis of the monetary policy in India.
 21

References

BOOKS:
 Tannan,M.L.,“Tannan’s Banking Law and Practice in India”, Wadhwa and
Company Nagpur, 21st Edn., Reprint 2007.
 Gupta S.N.,“The Banking Law”, Vol. II, Universal Law Publishing Co. Pvt. Ltd., 5th
Edn., 2010.
 Jhingan, M.L., “Money, Banking, International Trade and Public Finance”, Vrinda
Publication Pvt. Ltd., 7th Edn., Reprint 2007.
 Chaudhary, R.N., “Banking Laws”, Central Law Publications, Allahabad, 2015.

WEB SOURCES:

 www.mrunal.com<http://mrunal.org/2014/01/banking-monetary-policy-quantitative-
qualitative-tools-applications-limitations-msf-laf-repo-omo-crr-slr-revisited-before-
upcoming-urjit-article.html>
 www.economictimes.indiatimes.com<http://articles.economictimes.indiatimes.com/
2012-10-30/news/34817238_1_commercial-banks-deposit-rates-central-banks>