First lets see what exactly is CRR and SLR:-
CRR – Cash Reserve Ratio:- You’re a banker, you’ve to keep deposit that much ca$h in RBI.
SLR – Statutory Liquidity Ratio:- You’ve to keep that much gold/ca$h/bonds in your bank.
Lets assume you’re a banker, have 100 Rs. cr.
Out of that you were required to keep aside 1 cr. worth cash, gold etc. in SLR+CRR in Jan’11 as per RBI order.
So you’ve 99 cr. to give as loan and earn interest out of it.
But in Feb’11, RBI increases both ratios, so you’ve to keep aside 15 cr. in SLR+CRR.
So you only have 85 cr. to give as loan and earn interest out of it. Obviously you’ll charge more interest, when giving loans, to maintain same amount of profit.
How does this affect economy?
- Well Lower SLR+CRR, means bank can give more money as loan = lower interest rates = cheap loan = more people take loan to start business or building house or buying car = boost in 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 SLR+CRR = bank can give less money as loan = HIGHER interest rate = it becomes expensive to start a new factory, buy a new house / car/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.