This is a guest post by Dheeraj Singh. Dheeraj is a former fund manager for many years specializing in fixed income. Used to head fixed income at IL&FS Mutual Fund (before it got taken over by UTI) and subsequently worked with Sundaram BNP Paribas Mutual Fund (now Sundaram Mutual Fund) heading the fixed income desk. He runs Finanzlab Advisors, a treasury and risk management consultancy.
Table of Contents
- CRR – The Cash Reserve Ratio
- SLR – Statutory Liquidity Ratio
- Net Demand and Time Liabilities
- What constitutes NDTL?
- NDTL Base for CRR and SLR
- Demand Liabilities
- Time Liabilities
- Other demand and time liabilities (ODTL)
- Inter Bank Assets
- Liabilities not to be included in DTL / NDTL calculation
- NDTL Computation
- CRR Maintenance
- The nitty gritty of CRR maintenance
- Reporting Friday and Reporting Fortnight
- SLR Maintenance
Introduction: The Reserve Ratios – A Primer
Cash Reserve Ration(CRR) and Statutory Liquidity Ratio (SLR) are two important reserve ratios applicable to banks. These are also tools that the Reserve Bank of India uses in the conduct of its monetary policy.
The purpose of this primer is to provide a working knowledge and understanding of these reserve ratios. The content of this primer is based on RBI’s Master Circular on the subject and my own practical knowledge gained through the many years that I have been involved with the money and debt markets as a fund manager. Errors and Omissions if any are entirely mine. If you do spot any errors, please let me know in the comments.
CRR is that proportion of a bank’s Net Demand and Time Liabilities (NDTL) that it has to keep as cash deposits with RBI. Cash deposits do not mean physical cash, but a credit balance in a current account that every bank maintains at RBI.
This proportion is specified by RBI and could change from time to time. Currently (on the date this piece is being published), CRR is 4.75%.
CRR is governed by the provisions of Section 42 of the Reserve Bank of India Act, 1934.
There is no minimum level of CRR. We could go upto zero CRR (negative values are of course absurd). Similarly, there is no maximum. In theory, CRR can go upto 100%, which would mean RBI impounding the entire NDTL as a cash reserve.
Until the RBI Act was amended in 2007, the minimum value of CRR was statutorily fixed at 3% and the maximum was fixed at 20%. Both these limits (lower and upper) were removed by the amendment which came into effect in early 2007.
SLR is that proportion of a bank’s Net Demand and Time Liabilities (NDTL) that it has to maintain as investments in certain specified assets. SLR is governed by the provisions of Section 24 of the Banking Regulation Act.
There is no minimum stipulation on SLR (earlier there used to be a minimum stipulated SLR of 25% – but this was removed with an amendment to the Banking Regulation Act in 2007).
However, SLR can not exceed 40%.
It is quite apparent that to arrive at CRR or SLR we need to first calculate NDTL.
As the name suggest there are three broad components to NDTL.
- Demand Liabilities
- Time Liabilities; and
- A Netting Amount that is reduced from the Demand and Time Liabilities.
Additionally Demand and Time Liabilities (DTL) are further broken up into
- DTL to the banking system;
- DTL to Others; and
- Other DTL.
RBI has been empowered to decide on what kind of liabilities fall under DTL. In case of doubt, banks are advised to get a clarification from RBI.
Is CRR and SLR maintained on the same base – viz NDTL?
The short answer is, No.
While the NDTL calculation is broadly the same, there are some important differences when it comes to it’s use to compute CRR and SLR.
Some items are exempt for CRR purposes and so, the base on which CRR is to be maintained is not the same as the base on which SLR is computed. We shall look at these differences in the base a little later.
Demand Liabilities of a bank are liabilities which are payable on demand. These include
- current deposits;
- demand liabilities portion of savings bank deposits;
- margins held against letters of credit / guarantees;
- balances in overdue fixed deposits;
- cash certificates and cumulative/recurring deposits;
- outstanding Telegraphic Transfers (TTs);
- Mail Transfer (MTs);
- Demand Drafts (DDs);
- unclaimed deposits;
- credit balances in the Cash Credit account; and
- deposits held as security for advances which are payable on demand.
Time Liabilities of a bank are those liabilities that are payable other than on demand.
- fixed deposits;
- cash certificates;
- cumulative and recurring deposits;
- time liabilities portion of savings bank deposits;
- staff security deposits;
- margin held against letters of credit, if not payable on demand;
- deposits held as securities for advances which are not payable on demand; and
- gold deposits.
- interest accrued on deposits;
- bills payable;
- unpaid dividends;
- suspense account balances representing amounts due to other banks or public;
- net credit balances in branch adjustment account;
- Cash collaterals received under collateralized derivative transactions.
Any amounts due to the banking system which are not in the nature of deposits or borrowing are also to be included in other demand and time liabilities. Such liabilities may arise due to items like (i) collection of bills on behalf of other banks, (ii) interest due to other banks and so on
Assets with the banking system include
- balances with banks in current account;
- balances with banks and notified financial institutions in other accounts;
- funds made available to banking system by way of loans or deposits repayable at call or short notice of a fortnight or less; and
- loans other than money at call and short notice made available to the banking system.
Any other amounts due from banking system which cannot be classified under any of the above items are also to be taken as assets with the banking system.
The following liabilities are not be included in the DTL calculation for purposes of maintaining CRR and SLR
- Paid up capital, reserves;
- Any credit balance in the Profit & Loss Account of the bank;
- Amount of any loan taken from the RBI;
- Amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI;
- Net income tax provision;
- Amount received from Deposit Insurance and Credit Guarantee Corporation (DICGC) towards claims and held by banks pending adjustments thereof;
- Amount received from ECGC by invoking the guarantee;
- Amount received from insurance company on ad-hoc settlement of claims pending judgment of the Court;
- Amount received from the Court Receiver;
- The liabilities arising on account of utilization of limits under Bankers Acceptance Facility (BAF);
- District Rural Development Agency (DRDA) subsidy of Rs.10, 000/- kept in Subsidy Reserve Fund account in the name of Self Help Groups;
- Subsidy released by NABARD under Investment Subsidy Scheme for Construction/Renovation/Expansion of Rural Godowns;
- Net unrealized gain/loss arising from derivatives transaction under trading portfolio;
- Income flows received in advance such as annual fees and other charges which are not refundable;
- Bill rediscounted by a bank with eligible financial institutions as approved by RBI;
- Provision not being a specific liability arising from contracting additional liability and created from profit and loss account.
Computation of NDTL is a multi step process as follows :
- Compute Demand Liabilities to the banking system
- Compute Time Liabilities to the banking system
Take the sum of the above two to arrive at “DTL to the Banking System” – (A)
- Compute Demand Liabilities to others
- Compute Time Liabilities to others
Take the sum of the above to arrive at “DTL to Others” – (B)
Compute Other Demand and Time Liabilities – (C)
Calculate Assets to the banking system – (D)
Compute Net Inter Bank DTL by subtracting Assets to the Banking System from DTL to the banking system – (A-D)
If the Net Inter Bank DTL so calculated is negative or zero, it is ignored.
Thus NDTL is given by
NDTL = (A-D)+(B+C) if A-D is greater than zero,
NDTL = B+C if A-D is less than or equal to zero.
Banks are exempted from maintaining CRR on the following liabilities:
- Liabilities to the banking system in India.
- Credit balances in Asian Clearing Union (US$) Accounts.
- Demand and Time Liabilities in respect of their Offshore Banking Units (OBU)
For CRR purposes, NDTL should not include inter-bank term deposits / term borrowing liabilities of original maturities of 15 days and above and up to one year. Similarly banks should exclude their inter-bank assets of term deposits and term lending of original maturity of 15 days and above and up to one year for calculating inter bank assets (which is used to net off DTL and arrive at NDTL). The interest accrued on such deposits should also not be included.
As a consequence of the above, CRR is not maintained on
- Net Inter Bank DTL;
- Non Resident Deposits (NRE and NRNR);
- FCNR (B) – Short term and Long term;
- Exchange Earner’s Foreign Currency (EEFC) accounts;
- Resident Foreign Currency Accounts;
- Escrow Accounts by Indian Exporters;
- Foreign Credit Line for Pre-Shipment Credit Account;
- Overseas rediscounting of bills;
- Credit Balances in ACU (US dollar) Account;
Banks maintain CRR on a fortnightly average basis.
Say, a bank has NDTL of 100 crores and CRR is 5%.
The bank will thus have to maintain 5 crores as cash balance in its account with RBI. This 5 crores is calculated on a fortnightly average basis and the exact modality of how this is done is explained below.
To understand how this fortnightly average system works, we need to first understand the concept of reporting fortnight and reporting Friday.
Every alternate Friday is a reporting Friday. As I write, the last reporting Friday was March 23, 2012. So the next reporting Fridays would fall on April, 6, April 20, May 4 and so on. In case the reporting friday happens to be a holiday, the last previous working day is taken as the relevant reporting friday.
The 14 day period beginning on the Saturday immediately following a reporting Friday is called a reporting fortnight. A reporting fortnight therefore begins on a Saturday and ends on the reporting Friday.
As the name would suggest, banks report their business numbers (deposits, advances, investments etc.) to RBI as on these reporting Fridays.
For purposes of maintaining CRR and SLR, banks have to calculate their NDTL on every reporting friday.
However, the actual CRR and SLR maintenance happens with a lag of one fortnight.
So if the NDTL of a bank was 100 crores on March 9, 2012 and (assuming CRR is 5%) the bank would have to maintain an average cash balance of 5 crores in the reporting fortnight which begins on March 24.
This reporting and maintenance cycle is repeated over.
The situation can be better understood in the depiction below
Assume A, B and C are dates on a timeline that fall on alternating Fridays. Also, let’s say these are reporting Fridays.
Let’s also say that a bank calculates its NDTL on A and it turns out that the NDTL is equal to 100 crores.
If the CRR is 5%, the bank has to maintain an average cash balance of 5 crores over a fortnight. However, banks are given one fortnight’s time before they start maintaining these CRR balances.
So, for NDTL of 100 crores on A, the bank would have to maintain an average cash balance of 5 crores during the reporting fortnight ‘BC’.
To implement this, banks maintain CRR by the fortnightly product method.
Once again, it is easier to understand this with an example.
Let’s take our previous example:
If the bank has to maintain 5 crores on an average over the fortnight (14 days) it effectively has to maintain a product of
5 x 14 = 70 crores
Banks also have to maintain at least 70% of their stipulated CRR average as cash balance with RBI on every day of the reporting fortnight. This means that the bank in our example has to maintain
0.70 x 5 = 3.5 crores as cash balance on every day of the fortnight.
Let’s say for e.g. that the bank maintains the following cash balances on the first seven days of the fortnight.
- Day 1 : 4 crores
- Day 2 : 4.5 crores
- Day 3 : 3.5 crores
- Day 4 : 7 Crores
- Day 5 : 6 crores
- Day 6 : 5.5 crores
- Day 7 : 6.5 crores
Effectively the bank has maintained a product of
4 + 4.5 + 3.5 + 7 + 6 + 5.5 + 6.5 = 37 crores in the first 7 days.
(To calculate the product we multiply the amount maintained by the number of days the amount is maintained as balance. Since we are taking daily amounts we simply multiply the amounts by a factor of 1)
This means that the bank now needs to maintain only 70-37 = 33 crores as product in the second week of the reporting fortnight.
The minimum 70% stipulation means that banks can maintain neither too low a cash balance nor too high a cash balance on every day of the fortnight. If they maintain too high a cash balance during the initial days of the fortnight, it may so happen that the product build up is rapid and the bank may need to maintain a significantly lower cash balance during the last few days of the fortnight. This condition could lead to a breach of the minimum 70% rule which could incur penalties.
Banks thus have to be diligent in the calculation and maintenance of their fortnightly product.
Until this 70% rule was brought in sometime in 2002, banks were free to maintain any amounts, with the result that volatility in the money market was high, as banks’ requirement of funds varied sharply depending on their product build up during the reporting fortnight.
From the fortnight beginning June 24, 2006, penal interest will be charged as under
In case of default in maintenance of CRR requirement on a daily basis which is presently 70 per cent of the total CRR requirement, penal interest will be recovered for that day at the rate of:
Bank Rate + 3% per annum on the amount by which the cash balance actually maintained falls short of the prescribed minimum on that day.
If the shortfall continues on the next succeeding day/s, the penal interest levied is at the rate Bank Rate + 5% per annum.
In cases of default in maintenance of CRR on average basis during a fortnight, penal interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act, 1934. Under this section,The penal interest for default is:
if the average daily balance held at RBI by a bank during any fortnight is below the required average balance for CRR purposes, penal interest will be charged at the rate of
Bank Rate + 3% per annum
on the amount by which the balance falls short of the requirement.
If during the next succeeding fortnight the daily average balance is still below the required amount, the penal interest liable to be charged is
Bank Rate + 5% per annum
for each subsequent fortnight during which the bank defaults on maintaining the minimum required balance.
In addition to the above if the default on maintaining CRR continues for more than two fortnights meaning then any director, manager or secretary who knowingly and wilfully is a party to such defaults are liable to be fined a princely sum of five hundred rupees for every fortnight where such default occurs.
More tellingly if such a default on CRR continues for more than two fortnights, RBI has the power to prohibit the bank from accepting any fresh deposit.
The relevant clause in the RBI Act also says that if the bank contravenes this stipulation of not accepting any fresh deposit, then any manager, director or secretary who wilfully and knowingly is a party to such an action shall be fined a princely sum of five hundred rupees.
Of course, we know that RBI can take drastic action under other laws and these small fines (of five hundred rupees) stipulated in the RBI Act carry little meaning in the real sense.
As has been discussed above, SLR is that proportion of NDTL that the bank has to maintain in certain specified assets.
It should be noted that for SLR purposes NDTL is calculated slightly differently.
Firstly, all inter bank liabilities and assets are to be included for SLR purposes (unlike CRR wherein liabilities with original maturity between 15 days and one year were excluded)
Secondly, there are no exemptions (items on which no SLR is to be maintained) – unlike CRR where some items are exempt.
The specified investments that are eligible for SLR purposes are
- Gold valued at a price not exceeding the current market price
- Investment in the following instruments which will be referred to as “Statutory
- Liquidity Ratio (SLR) securities”:
- Dated government of india securities
- Treasury Bills of the Government of India;
- State Development Loans (SDLs) of the State Governments issued from time to time under the market borrowing programme; and
- Any other instrument as may be notified by the Reserve Bank of India.
Of the above, any securities which are encumbered in any way can not be included for SLR purposes. This also includes situations wherein the security may have been submitted to RBI as collateral under the daily liquidity adjustment facility (the commonly understood RBI repo window).
Unlike CRR which is maintained as an average over the entire fortnight, SLR has to be maintained on all the days of the relevant fortnight.
The relevant fortnight and NDTL are however the same as in the case of CRR.
SLR is therefore maintained on the NDTL as on the reporting Friday of two fortnights ago.(just like in the case of CRR).
If a bank fails to maintain the required amount of SLR, it shall be liable to pay to RBI in respect of that default, penal interest for that day at the rate of three per cent per annum above the Bank Rate on the shortfall.
If the default continues on the next succeeding working day, the penal interest may be increased to a rate of five per cent per annum above the Bank Rate for the concerned days of default on the shortfall.
In my opinion, the bank rate continues to exist only because of the penalty provisions on default in maintenance of reserve requirements.
Had these penalty provisions not been linked to the bank rate under the law, we would have possibly seen the demise of the bank rate as an instrument of monetary policy.
Under the current situation doing away with the bank rate would require amending the RBI Act and the Banking Regulation Act – something that only the Parliament can do. Amending laws take significant effort, and therefore we might have to live with the bank rate for some more time.
RBI has anyway made the bank rate irrelevant by equating it to the rate at which it lends money under the marginal standing facility (MSF). MSF is currently pegged at one percent above RBI’s repo rate.
Update: It seems I may have been a bit enthusiastic in predicting the demise of the bank rate. Sec 372A of the Companies Act says that companies can not lend to each other at an interest rate lower than the bank rate. So RBI’s increase in bank rate ensures that inter corporate loans or investment in bonds can only be made if the coupon rate is at least the bank rate. Of course there are ways around this provision – if one is structuring a deal. However, this just goes to show, how laws enacted ages ago, need to change with the times. I’m sure RBI probably did not intend to regulate the rate of interest paid out in the inter corporate loans market (or maybe they actually did), when they changed the bank rate recently and linked it to the marginal standing facility rate.