Repo rate, reverse repo, CRR and SLR: the difference for UPSC

When the RBI wants to slow the economy it raises the repo rate. When it wants to drain liquidity it can raise the CRR. A question asking which of the following reduces money supply may have all four tools as plausible answers, in different contexts.

The exam is testing whether you know which tool does which job. That is a narrower question than it sounds, and it is easier to answer once the four are separated by function rather than by definition.

The two rates

Repo is the rate at which the RBI lends short-term money to banks against government securities, with an agreement to repurchase them. The bank sells securities, borrows cash, and buys the securities back later at a slightly higher price. The difference is the interest.

Reverse repo is the mirror image. The RBI borrows from banks, taking their excess cash and paying interest on it. A higher reverse repo encourages banks to park money with the RBI instead of lending it out.

For a long time these two rates bounded the call money market: repo as the ceiling, reverse repo as the floor. That changed in April 2022, when the RBI introduced the Standing Deposit Facility. The corridor is now bounded by the Marginal Standing Facility at the top and the SDF at the bottom, with the repo rate in the middle. The reverse repo still exists but sits below the floor and is effectively dormant.

That detail is worth knowing because older material still describes the repo-reverse repo corridor, and a question can be built on the difference.

The two ratios

CRR, the cash reserve ratio, is the share of a bank's net demand and time liabilities — essentially deposits — that must be held as cash with the RBI. Banks earn nothing on it. If the ratio is 4 per cent, then for every hundred rupees deposited, four sit idle at the central bank and ninety-six can be lent.

SLR, the statutory liquidity ratio, is the share that must be held in liquid assets: cash, gold, or government securities. Unlike the CRR, these assets earn a return, because the government securities pay interest. The SLR has come down from a statutory maximum of 40 per cent to around 18 per cent over three decades of banking reform.

What a change actually does

CRR and SLR are not the same kind of tool

They are often taught as a pair, but they do different jobs.

The CRR is monetary. It is changed to manage liquidity, and it can be changed quickly. The money sits with the RBI and earns nothing, so a change passes straight through to lending capacity.

The SLR is prudential. Its original purpose is to ensure that a bank holds enough safe, sellable assets to meet withdrawals, and a secondary effect is that it creates a captive market for government borrowing. It is changed rarely, through policy review, and it is not used for month-to-month liquidity management.

One test separates them. If the question is about safety or government debt, it is the SLR. If it is about the volume of lendable funds, it is the CRR.

The order the RBI reaches for them

For a demand-driven inflation problem, the sequence is roughly this.

The repo rate moves first. It is the policy rate, it is signalled through the Monetary Policy Committee, and it works through the whole structure of borrowing costs.

The CRR is used when the liquidity surplus is large enough that rate signals are not transmitting properly, or when the RBI wants a broad, immediate reduction in lendable funds. It is a blunt instrument and is used sparingly.

The SLR is the last resort for monetary purposes, because changing it disrupts the government securities market and the banking system's balance sheet at the same time.

A repo change alone signals measured action. A repo change plus a CRR change signals something more urgent.

The numbers worth knowing

The policy rate is set by the six-member Monetary Policy Committee, which meets at least four times a year and in practice every two months. Its mandate is to keep CPI inflation at 4 per cent, within a band of 2 to 6 per cent.

Changes are announced in basis points. One basis point is one hundredth of a percentage point, so a 25 basis point increase takes the repo rate from 6.50 to 6.75 per cent.

The CRR is maintained on a fortnightly average, with a daily minimum requirement. Failure to maintain it attracts penalties, which is why banks manage their cash positions closely around reporting dates.

Common errors

Treating repo and reverse repo as two directions of the same loan. They are, mechanically, but they sit in different parts of the corridor and one of them has been superseded as the floor.

Assuming the CRR pays interest. It does not. The SLR does, through the securities held.

Assuming a higher SLR is always contractionary in the short run. It reduces lendable funds, but it also supports government borrowing, which is why it survives as a prudential tool rather than a monetary one.

Confusing the policy rate with the rate you get. The repo rate is what banks pay the RBI. Your home loan is priced off the repo plus a spread, and transmission takes weeks or quarters, not days.

The monetary side connects to the inflation diagnosis, because the right response depends on which type is running. For the fiscal side of the same policy mix, see fiscal versus revenue deficit, and for how the rupee carries the result, the balance of payments.