Question

Define cash reserve ratio and statutory liquidity ratio. How can they be used to control the situation of excess money supply?

Answer 1

Cash reserve ratio is the share of a bank's total deposit that is mandated by the Reserve Bank of India to be maintained with the latter in the form of liquid cash. Statutory liquidity ratio is defined as the share of bank's total deposit that it needs to maintain itself as liquid assets.

$Incashreserveratio$

To control the money supply in the economy, Reserve Bank of India increases the cash reserve ratio, sucking the loan able funds available with the banks. This in turn slows down investment and reduces the supply of money in the economy. As a result, the growth of economy is negatively impacted.

$Instatutoryliquidityratio$

To control the money supply in the economy, central bank will increase statutory liquidity ratio. As SLR is increased banks will have to keep more liquidity with themselves.So the less amount of funds will be available to the banks for credit creation. The total money supply in the economy will decrease, this will lead to less demand.