Components of Legal reserve ratio are Statutory Liquidity Ratio and Cash Reserve Ratio.
According to the Legal Reserve requirement, commercial banks are obliged to maintain reserves.
It is a very quick and direct method for controlling the credit-creating power of commercial banks.
Commercial Banks are required to maintain reserves on two accounts:
(i) Cash Reserve Ratio (CRR): It refers to the minimum percentage of net demand and time deposits, to be kept by commercial banks with the central bank.
A change in CRR affects the ability of commercial banks to create credit.
For instance, an increase in CRR reduces the excess reserves of commercial banks and limits their credit-creating power.
(ii) Statutory Liquidity Ratio (SLR): It refers to a minimum percentage of net demand and time deposits that commercial banks are required to maintain with themselves.
SLR is maintained in the form of designated liquid assets such as excess reserves, unencumbered, government and other approved securities, or current account balances with other banks.
Change in SLR affects the freedom of banks to sell government securities or borrow against them from the central bank.
An increase in SLR reduces the ability of banks to give credit and vice-versa.
The Reserve Bank can influence the credit creation power of the banks by making changes in CRR or/and SLR
The other name of the Legal Reserve Ratio is the Variable Reserve Ratio Method.
Unencumbered securities* refer to those securities that are not acting as security for loans from the central bank.
Approved securities* refer to those securities whose repayment is guaranteed by the government.