Bank Investments in Government Securities Quiz

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Questions and Answers

What is the purpose of increasing the SLR by the RBI?

To boost people's borrowing and increase liquidity in the economy.

To decrease liquidity in the economy and fight inflation. (correct)

To decrease the government's borrowing requirements.

To encourage banks to lend more money in the economy.

How does a decrease in SLR impact interest rates offered by banks?

Interest rates decrease to encourage borrowing and increase liquidity.

Interest rates decrease because banks have more funds available to lend.

Interest rates increase because banks have to reduce lending. (correct)

Interest rates increase to slow down borrowing and limit liquidity.

What does Cash Reserve Ratio (CRR) refer to in banking?

The interest earned on bank deposits kept with RBI.

The portion of bank deposits that banks can freely lend out.

The ratio of bank profits that must be kept reserved for future loans.

The fraction of bank deposits banks must keep in cash with RBI. (correct)

What is the main purpose of Repo Rate changes by the RBI?

To influence inflation and liquidity in the economy. Signup and view all the answers

How does the RBI use Liquidity Adjustment Facility (LAF) to manage liquidity?

By allowing banks to borrow money from RBI on collateral. Signup and view all the answers

How does a decrease in CRR affect the liquidity in the banking system?

Increases liquidity by making more funds available for lending. Signup and view all the answers

What impact does increasing the Cash Reserve Ratio (CRR) have on the money available for lending by banks?

Decreases the money available for lending Signup and view all the answers

In what scenario is the CRR decreased by the Reserve Bank of India (RBI)?

To fight deflation Signup and view all the answers

What happens when a bank falls short of meeting its Cash Reserve Ratio (CRR) requirements?

The RBI collects interest on the shortfall at a higher rate Signup and view all the answers

Why do commercial banks find it irritating when the RBI collects interest on their shortfall in Cash Reserve Ratio (CRR)?

It reduces their profitability Signup and view all the answers

What is one of the justifications for commercial banks to request a reduction in the Cash Reserve Ratio (CRR)?

To improve their liquidity position Signup and view all the answers

What happens if a bank fails to maintain the required levels of CRR/SLR?

RBI can impose a penalty on the bank Signup and view all the answers

What is the current penalty rate for banks not maintaining the required levels of CRR/SLR?

(Bank rate + 2%) Signup and view all the answers

What is the purpose of SLR (Statutory Liquidity Ratio) in the banking system?

To lock in excess liquidity and prevent lending Signup and view all the answers

Why do banks usually keep more than the required SLR?

To prevent liquidity shortages during bank runs Signup and view all the answers

How does SLR help in managing liquidity in the banking system?

By ensuring banks have liquid assets to meet short-term obligations Signup and view all the answers

Why does the government historically keep bank's SLR high?

To cover the government's fiscal deficit by using g-secs as collateral Signup and view all the answers

Study Notes

Monetary Policy Tools

SLR (Statutory Liquidity Ratio) is used to control inflation, help banks during times of bank run, and help the government in meeting its borrowing requirements.
SLR is the portion of NDTL (Net demand and time liabilities) that banks should keep in the form of designated liquid assets like cash, gold, and government securities.
SLR has been progressively brought down from 38.5% in 1991 to 18.50% (2020).

Inflation Control

To fight inflation, SLR is increased, which makes banks keep more money as reserve, decreasing the funds available for lending in the economy.
This leads to higher interest rates, discouraging people from borrowing, and ultimately reducing liquidity in the economy and inflation.

Recession or Slowdown

To fight recession or slowdown, RBI decreases SLR, allowing banks to increase liquidity in the market, decrease interest rates, and encourage people to borrow more.

Cash Reserve Ratio (CRR)

CRR is the portion of bank deposits that a bank should keep with the RBI in cash form, and RBI pays no interest on CRR deposits.
CRR is adjusted to manage liquidity and inflation, and if a bank doesn't maintain the required levels of CRR, RBI can impose a penalty.

Penalty for Non-Compliance

The penalty rate for non-compliance is (bank rate +2%), currently 4.25% (Aug 2020).

Uses of SLR

SLR is used to remove excess liquidity of the banking system, control inflation, and mobilize revenue for the government.
SLR helps banks during times of bank run by keeping a part of the money in near cash, allowing them to meet any unexpected demand from depositors at short notice.

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Description

Test your knowledge on how banks invest part of their Net Demand and Time Liabilities (NDTL) in government securities to meet SLR requirements and help the government meet its borrowing needs. Understand how changes in SLR can impact inflation, bank lending, interest rates, and borrowing behavior of individuals.