Statutory Liquidity Ratio-SLR


RBI uses many monetary policies for controlling and stabilizing the economy and one among them is SLR. The primary goal of the RBI is to make sure that prices of commodities are maintained at an optimum level and to administer the supply and demand of money flow into the economy. It uses instruments like credit ceiling, statutory liquidity ratio, cash reserve ratio, bank rate policy, open market operations, credit authorization scheme, repo rate, reverse repo rate, moral suasion, etc. Each of these instruments plays a significant role in operating the economy of the nation.

According to the Government of India, the commercial banks are required to maintain a certain amount of reserve to provide credit to their customers. This reserve can be in the form of cash, gold reserves and RBI approved securities. It is managed by a ratio determined by RBI, known as the statutory liquidity ratio. It is the ratio of liquid assets to demand and time liabilities. The Reserve Bank of India has the authority to increase the rate up to 40% which restricts the ability of banks to contribute money to the economy.


Components of SLR

SLR’s component includes net balance in the current account and investment in government securities, cash in hand, amount of gold owned by the bank etc. It is mandatory for all commercial banks to maintain SLR according to Section 24 and Section 56 of the Banking Regulation Act.

  • Liquid Assets- Liquid assets are those assets that can be readily converted into cash. For example, gold, treasury bills, the government approved securities, government bonds, and cash reserves. It also includes securities, eligible under Market stabilization scheme and Market Borrowing schemes.
  • Net Demand and Time Liabilities (NDTL)- It is the net demand and time liabilities that can be reserved by commercial banks and other banks. Demand deposits include the liabilities that the bank is required to pay when demanded. These are current deposits, demand drafts, balances the overdue fixed deposits and demand liabilities form the savings bank deposits.

Time deposit includes the deposits that can be used on maturity, means that cannot be withdrawn by depositor immediately. He has to wait until the lock-in period is over to access his funds.

  • SLR Limit-It has an upper limit of 40 percent and a lower limit of 23 percent.

Roles of SLR:

  1. To restrict the commercial banks from liquidating- In the absence of Statutory Liquidity Ratio, the Cash Reserve Ratio goes up. As a result, the bank goes low on cash and will be unable to control bank credit. So to ensure the solvency of commercial banks SLR is necessary.
  2. To control the flow of bank credit- The Reserve Bank of India has the authority to increase or decrease the SLR. It is raised during inflation and declined during the recession.

Impact of SLR on the investors-

The SLR is considered as one of the references while determining the base rate (minimum lending rate). This is the minimum rate below which banks are not allowed to lend money. Its role is to check the transparency concerning transactions in the credit market. It also helps the bank to cut down on their cost of lending so that the banks will be able to offer loans at affordable interest rates. However, this condition also checks the lending capacity of the bank. To keep the demand in control, there is a need to increase the lending rates.


Consequences if SLR is not maintained-

In India, every bank is supposed to maintain SLR. To ensure its maintenance, banks have to report their latest Net Demand and Time liabilities to RBI every fortnight Friday. If not maintained, RBI imposes a penalty of 3% over the bank’s interest rate annually. In case of defaulting on the next working days too will lead to a penalty of 5%.


Determination of correct SLR level:

Banks have a specific component called risk capital. It includes funds used for high risk, high reward investment. It is crucial to invest in it wisely. This can result in a massive amount of gain or loss. So, the correct level of SLR would be equal to the level of the risk capital of any bank.


Reasons for the introduction of monetary policies:

  • Monetary policies help to keep prices in the economy stable and assists in economic development
  • It helps to increase bank credit as well as regulate financial supply so that the bank’s output is not affected. These monetary policies help to ensure that banks can meet their credit requirements.
  • The monetary policy checks the piling of money and inventories which results in the building up of sick units. To restrict this, the RBI makes sure that bank’s do not hold unused reserve.
  • It helps the banks to be flexible. The RBI interferes in any bank’s operations only in the time of absolute need.
  • The monetary policy aims at raising the output and improving the performance of fixed investments of banks which is done by restriction of unnecessary fixed investments.

It is essential that these assets are reserved in a non-cash form which could be bonds, precious metals, and other government-approved securities.


Facts

  • The RBI has decided to reduce SLR, the part of funds which banks are required to reserve in treasury bills and other instruments, by 0.25% every quarter starting from January.
  • The steady reduction in statutory liquidity ratio (SLR) will continue till it reaches 18%. The current SLR is 19.5%.
  • This may release funds locked in government securities and add to lendable liquidity
  • The RBI has settled the key repo rate unchanged at 6.50%. It also cut the retail inflation projection to range between 2.7-3.2% during the second half of the current financial year.

 Difference between SLR and CRR

SLRCRR
It deals with all the liquid assets including both cash and gold reservesIt deals with only cash reserves
Banks receive interest on SLR reservesBanks earn no Interest on it.
The primary purpose is to control the bank’s ability for credit expansionThe primary purpose is to control liquidity in the banking system
Reserve is held with the bank itself, which they need to keep in liquid asset formReserves are maintained by RBI

Reason for imposing SLR

The main reason behind SLR is to keep the banks’ safe from becoming a sick unit. Financial activity with any third person is a risky affair. In order to protect banks from any risk of getting sick, RBI imposes SLR and keeps a small amount of fund safe with it. You may wonder how SLR help in economic development. it has promoted and improved the debt management programme of the Indian government. This programme help banks’ to offer loans to all sectors of the economy.

Read More-

Repo Rate & Reverse Repo Rate

CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.