Concept of liquidity, cash reserve ratio(CRR), statutory liquidity ratio (SLR), Repurchase obligations (REPO) and Reverse repo rate

Government and RBI has some tools to measure through which inflation can be controlled. You may have read in the newspaper that the RBI has increased the repo rate or cash reserve ratio or statutory liquidity ratio. So these are the measure through which inflation can be controlled. 

Concept of Liquidity 

Any assets converted in cash easily such as gold is called liquid. Lets take an example to understand the concept, if you go to market for selling a pen then you cannot find buyers of pen easily. This means that pen is illiquid. So it depends on situation.

Now to understand the concept of cash reserve ratio, first we understand about banking system. In a bank people deposit their money. This is called liability where money is deposited in bank. With this money, the bank will give loan to Tata, Birla, Ambani and many others. Then they will return money with 5%, 6% interest.This side of giving loan by the bank is known as assets side. 

So in brief word we can understand liability as given below:

Liability

 Money that is returned by the bank for its depositor because it is not a bank money. There are two types of liabilities

• Demand deposit (saving account)
• Time deposit (for a fixed time such as fixed deposit, recurring deposit)

As we know that bank will not give their service free. They deduct money from their deposited money in form of sms charges, atm charges and many more. After that the money left in the form of demand and time liabilities is called Net demand and time liabilities (NDTL) . Based on NDTL, bank measures CRR and SLR.

Cash Reserve Ratio 

When banks reserve some percentage of NDTL in the form of cash in RBI chest, it is called cash reserve ratio. 

Statutory Liquidity Ratio (SLR) 

When bank reserve some percentage of NDTL in own chest in the form of liquid (Cash, Gold and Government security). 

Let's take an example that bank have ₹100 and today SLR in india is 18% means bank have to reserve ₹18 in the form of liquid. 

So the basic difference between CRR and SLR is that in CRR bank reserve only cash in RBI chest but in SLR bank reserve in its own chest in the form of cash, gold and government securities. 

Government securities 

Government securities is a debt given by banks to government. Mainly banks reserve government securities in SLR because it gives interest to bank otherwise no interest given by RBI to banks in CRR. 

Repo Rate

When bank takes money for short term from the RBI and in return gives government securities to RBI but RBI tells bank that you are bound to repurchased your government securities when you will return money. This government securities are not SLR, these are extra government securities purchased by bank because they know that RBI give money only in government securities. This is the concept of repo rate. 

Reverse Repo Rate

When banks have extra money and their is no tata and birla to take loans from the banks then banks give money to RBI for some days and in return take government securities from RBI. From that government securities bank earn interest.

Repo rate and Reverse repo rate are short term instrument (maximum 14 days).

Also read other articles 

• Best mutual funds in India 

• Benefits of dry fruits 

• How to clear someone's doubts

• Why Health insurance is necessary