CDS (I) 2020 General Knowledge · Question 52 of 120

Correct — B, the share of Net Demand and Time Liabilities that banks have to hold as balances with the RBI. The cash reserve ratio is fixed under the Reserve Bank of India Act, and its defining feature is where the money sits: in the bank's current account with the Reserve Bank, not in its own vaults and not in securities. No interest is paid on those balances. Two of the wrong options are near-misses built on that single distinction. Holding a share of liabilities as liquid assets — cash, gold and approved securities, kept by the bank itself — is the statutory liquidity ratio, a different instrument under a different statute. Holding it as part of the bank's own cash reserves misses the point that the reserve is with the central bank. When the ratio is raised, banks have less to lend, and credit tightens.

• (a)the share of Net Demand and Time Liabilities that banks have to hold as liquid assets — This is the statutory liquidity ratio. Under the SLR a bank holds cash, gold and approved securities itself and earns a return on the securities; under the CRR the money is a non-earning balance with the Reserve Bank.
• (c)the share of Net Demand and Time Liabilities that banks have to hold as part of their cash reserves — The nearest miss in the set. It gets the base right and the location wrong: the CRR is not vault cash retained by the bank but a balance maintained with the Reserve Bank of India.
• (d)the ratio of cash holding to reserves of banks — A ratio of cash to reserves is a different quantity altogether and is not a regulatory requirement. The CRR is measured against Net Demand and Time Liabilities, which is the deposit base, not against reserves.

Net Demand and Time Liabilities are essentially a bank's deposits — demand deposits payable on call and time deposits payable at maturity — net of inter-bank items. Both the cash reserve ratio and the statutory liquidity ratio are struck as percentages of that base, which is why they look alike on paper. The difference is custody and return: CRR balances are held with the Reserve Bank and earn nothing, SLR assets are held by the bank and mostly do.

Three of the four options open with the same eleven words, so the examiner has put the whole question in the tail of each sentence. Read only the tails and the choice becomes a three-way test — liquid assets, balances with the RBI, or the bank's own cash reserves — and only the middle one names the Reserve Bank as custodian. It is worth carrying the effect as well as the definition: a rise in the CRR drains lendable resources out of the banking system, which is the point of using it as a monetary tool.

• The cash reserve ratio is the share of Net Demand and Time Liabilities that banks must maintain as balances with the Reserve Bank of India.
• CRR balances earn no interest and are not held as vault cash by the bank itself.
• The statutory liquidity ratio, by contrast, is held by the bank as cash, gold and approved securities.
• Both ratios are computed on Net Demand and Time Liabilities, the bank's net deposit base.
• Raising the CRR leaves commercial banks with less money to lend, which tightens credit.

• Confusing CRR with SLR; the base is the same and only the form and custodian differ.
• Thinking CRR balances earn interest — they do not.

As a straight definition, as a CRR-versus-SLR contrast, or as an effect question on what a change in the ratio does to lending.

• practice — not a real PYQ

  The statutory liquidity ratio requires a bank to hold a share of its Net Demand and Time Liabilities in the form of

  • (a)a balance with the Reserve Bank of India
  • (b)cash, gold and approved securities held by the bank itself
  • (c)foreign currency assets
  • (d)loans to priority sectors

  Answer(b) cash, gold and approved securities held by the bank itself — which is exactly what separates the SLR from the CRR.

• practice — not a real PYQ

  When the Reserve Bank of India raises the cash reserve ratio, the immediate effect is that

  • (a)commercial banks have less money to lend
  • (b)commercial banks have more money to lend
  • (c)the Reserve Bank has less money to lend
  • (d)the government has more money to spend

  Answer(a) commercial banks have less money to lend — a larger share of deposits must sit idle with the Reserve Bank.