The Cooperative Bank's New Deposit and a ₹40 Crore Loan Request
A small cooperative bank has just received a new deposit of ₹50 crore. Its required cash reserve ratio (CRR) is 4% and statutory liquidity ratio (SLR) is 18%. Before the deposit, the bank had no excess reserves and held exactly the required reserves and SLR securities. A local infrastructure company asks for a ₹40 crore term loan. The manager wants to know whether the deposit can support the loan without borrowing from the RBI or selling assets. The bank must hold CRR as cash with the RBI and SLR in approved securities; both are treated as required before any lending. Assume the bank wants to keep no voluntary excess reserves, and that the loan is disbursed and spent in a way that does not return to this bank as a new deposit. Later the RBI raises CRR to 5.5% and SLR to 20%.
1. Calculate the required CRR and SLR on the new deposit and the maximum amount the bank can lend. Can it fully meet the ₹40 crore request?
Read the worked answer
Required CRR = 4% of ₹50 crore = 0.04 × 50 = ₹2 crore.
Required SLR = 18% of ₹50 crore = 0.18 × 50 = ₹9 crore.
Total required reserves and securities = ₹2 crore + ₹9 crore = ₹11 crore.
Lendable funds from the new deposit = ₹50 crore − ₹11 crore = ₹39 crore.
The bank had no excess reserves before the deposit, so it has no additional lendable resources. The maximum loan is therefore ₹39 crore. The infrastructure company asks for ₹40 crore, which is ₹1 crore more than the bank can support from this deposit alone. Without borrowing from the RBI or selling other assets, the bank cannot fully meet the request. It could lend ₹39 crore and ask the company to arrange the remaining ₹1 crore elsewhere.
2. Recalculate the bank's lendable funds if the RBI raises CRR to 5.5% and SLR to 20%. Explain the effect on this bank and on credit creation in the banking system.
Read the worked answer
At CRR = 5.5%: required CRR = 0.055 × ₹50 crore = ₹2.75 crore.
At SLR = 20%: required SLR = 0.20 × ₹50 crore = ₹10 crore.
Total required = ₹2.75 crore + ₹10 crore = ₹12.75 crore.
Lendable funds = ₹50 crore − ₹12.75 crore = ₹37.25 crore.
The shortfall against the ₹40 crore request rises from ₹1 crore to ₹2.75 crore. The bank must reduce lending, hold more cash with the RBI, and hold more approved securities. For the banking system, a higher CRR reduces the simple deposit multiplier: before, 1/0.04 = 25; after, 1/0.055 ≈ 18.18. A higher SLR also immobilises a larger part of each deposit in securities, reducing the lendable base. Credit creation therefore slows, borrowers may face credit rationing, and the bank may need to call back some loans or sell assets if it wants to expand lending.
3. The manager says, 'A deposit is a liability, so it cannot create a loan.' Evaluate this statement using the bank's balance sheet and the idea of credit creation.
Read the worked answer
The statement is only half true. A deposit is certainly a liability of the bank because the bank owes the depositor that money. But the cash received against the deposit is an asset. The bank does not lend the entire deposit: it keeps the required CRR as cash and holds SLR securities, then lends the excess. In this case, ₹50 crore of new deposits supports ₹37.25 crore to ₹39 crore of lending, depending on the reserve ratios.
When the bank lends, it creates a claim that the borrower uses to make payments. If the seller deposits the proceeds in another bank, that bank receives a new deposit, keeps its required reserves, and lends the remainder. The process continues, so deposits create further deposits. This is credit creation.
However, a single bank cannot create credit beyond its excess reserves. The manager is wrong to say a deposit cannot create a loan at all, but also wrong if he imagines unlimited creation by one bank. The system multiplier depends on reserve ratios and leakages, and here the bank is constrained by CRR and SLR.