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Difficulty: MediumMonetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets

Consider the following statements regarding the quantitative monetary policy instruments utilized by the Reserve Bank of India (RBI):

1. The Cash Reserve Ratio (CRR) is maintained by commercial banks under Section 42 of the Reserve Bank of India Act, 1934, as a specified percentage of their Net Demand and Time Liabilities (NDTL) held with the RBI, on which banks receive no interest earnings.
2. The Statutory Liquidity Ratio (SLR) is mandated under Section 24 of the Banking Regulation Act, 1949, and can be maintained in liquid assets such as cash, gold, and unencumbered approved government securities.
3. An upward revision in the Cash Reserve Ratio (CRR) by the RBI enhances the primary credit creation capacity of commercial banks by expanding their lendable reserve base.

Which of the statements given above is/are correct?

  1. 1 and 2 onlyAnswer
  2. B
    2 and 3 only
  3. C
    1 only
  4. D
    1, 2, and 3

Answer

Statements 1 and 2 only are correct.
Statements 1 and 2 accurately state the legal statutory frameworks governing cash reserve and statutory liquidity requirements in India. Under Section 42 of the Reserve Bank of India Act, 1934, scheduled commercial banks maintain CRR with the RBI without receiving interest earnings. Under Section 24 of the Banking Regulation Act, 1949, banks maintain SLR in specified liquid forms including cash, gold, and unencumbered government bonds. Statement 3 is wrong because raising CRR locks up liquidity and reduces bank credit expansion capacity.

Step-by-Step Solution

1
Analyze Statement 1 regarding statutory provisions and interest on CRR.
Statement 1 is correct. Under Section 42(1) of the RBI Act, 1934, scheduled commercial banks must maintain CRR as a balance with the RBI. RBI does not pay interest on CRR balances.
Verify the legal basis and financial rules governing Cash Reserve Ratio balances.
2
Analyze Statement 2 regarding SLR mandate and permissible asset forms.
Statement 2 is correct. Section 24 of the Banking Regulation Act, 1949, empowers RBI to mandate SLR in liquid assets comprising cash, gold, and unencumbered G-Secs/Treasury Bills.
Verify the governing act and eligible asset classes for Statutory Liquidity Ratio compliance.
3
Analyze Statement 3 regarding the economic transmission mechanism of raising CRR.
Statement 3 is incorrect. Increasing CRR forces banks to transfer a larger portion of NDTL to the RBI, directly reducing their excess loanable reserves and money multiplier capacity.
Evaluate the quantitative monetary policy impact of CRR adjustments on market liquidity and bank lending.

Key Concept

Statutory Foundations and Liquidity Transmission of CRR and SLR
Estimated Time:1m 15s
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Topics

Monetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets