Legal Reserve Ratio or LRR refers to a portion of the total deposits of a commercial bank which it has to keep with the central bank or with itself in the form of cash, marketable securities or gold. There are two components of LRR, i.e., (i) Cash Reserve Ratio (CRR) and (ii) Statutory Reserve Ratio (SLR).
The bank rate, also known as the rediscount rate is the rate a at which the central bank extends loan to commercial banks or rediscounts the commercial bills brought by the commercial banks in the case of financial need.
As far as LRR is concerned, the loanable capacity of a commercial bank gets reduced by the amount of LRR. By increasing the LRR, the excess reserve of the commercial bank is reduced which restricts the credit-granting capacity of the commercial bank. Similarly, when the bank rate is raised, the loan becomes costlier for the commercial banks which also raise interest rates on loans for general customer. The rise in both these reduces the aggregate demand and the inflationary gap.