MUMBAI, Sept 1 (Reuters) - India's central bank has asked banks to calculate their base lending rates on the basis of the marginal cost of funds instead of the current practice of average cost and to implement the new rules by April 1, 2016.

The Reserve Bank of India wants banks' lending rates to be sensitive to policy rates, it said in a circular on draft base rate guidelines on Tuesday.

Indian banks have been reluctant to lower their base lending rates, citing high cost of funds, despite the three policy rate cuts by the RBI.

The RBI also urged banks to move to external financial benchmarks for pricing their deposits and loans in the medium term. 

Not many people, except those who are in banking industry or are students of economics know about terms like CRR and SLR. This is because theses are financial instruments in the hands of apex bank of India, the RBI (Reserve Bank of India), to control liquidity available to commercial banks. Thus, despite having similarity in nature and purpose, there are many differences between CRR and SLR that will be highlighted in this article.

CRR

CRR stands for Cash Reserve Ratio, and specifies in percentage the money commercial banks need to keep with themselves in the form of cash. In reality, banks deposit this amount with RBI instead of keeping this money with them. This ratio is calculated by RBI, and it is in the jurisdiction of the apex bank to keep it high or low depending upon the cash flow in the economy. RBI makes judicious use of this amazing tool to either drain excess liquidity from the economy or pump in money if so required. When RBI lowers CRR, it allows banks to have surplus money that they can lend to invest anywhere they want. On the other hand, a higher CRR means banks have lesser amount of money at their disposal to distribute. This serves as a measure to control inflationary forces in economy. Present rate of CRR is 5%.

SLR

It stands for Statutory Liquidity Ratio and is prescribed by RBI as a ratio of cash deposits that banks have to maintain in the form of gold, cash, and other securities approved by RBI. This is done by RBI to regulate growth of credit in India. These are un-encumbered securities that a bank has to purchase with its cash reserves. The present SLR is 24%, but RBI has the power to increase it up to 40% ,if it so deems fit in the interest of the economy.

What is the difference between CRR and SLR?

• Both CRR and SLR are instruments in the hands of RBI to regulate money supply in the hands of banks that they can pump in economy

• CRR is cash reserve ratio that stipulates the percentage of money or cash that banks are required to keep with RBI

• SLR is statutory liquidity ratio and specifies the percentage of money a bank has to maintain in the form of cash, gold, and other approved securities

• CRR controls liquidity in economy while SLR regulates credit growth in the country

• While banks themselves maintain SLR in liquid form, CRR is with RBI maintained as cash.

Rising inflation, leads to increase in expenses, which could lead employers to cut costs and subsequently layoff people or not hire more.

A central bank uses monetary policy as a tool to rein in inflation. Such tools could be raising interest rates.

High unemployment could also indicate a slowdown in economy, and the monetary policy may loosen I.E. Cut interest rates to boost the economy.

If there is greater inflation,there will be rise in market prices and if there is  no subsequent rise in wages it will be difficult for employees to sustain thier livelihood. 

Also the industries may downsize thier employee strength to overcome the stress on rise in wages.This leads to rise in unemployment. 

To control the inflation, the central bank uses monetary policy as an instrument to control the interest rates.