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Statutory Liquidity Ratio (SLR) Explained: Meaning, Objectives



Statutory liquidity ratio
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SLR stands for Statutory Liquidity Ratio, which refers to the minimum percentage of  deposits that a commercial bank is required to keep in the form of gold, cash, and other approved securities. These deposits are held by the bank, and the RBI (Reserve Bank of India) does not interfere with them. However, the RBI has the authority to increase the ratio up to 40% depending on the current market conditions. Currently, the SLR requirement is set at 18%.

What is the Statutory Liquidity Ratio (SLR)?

The Statutory Liquidity Ratio (SLR) is a mandate from the Reserve Bank of India requiring that banks keep a fixed percentage of their deposits in quick-to-cash assets like government bonds, cash, or occasionally gold. This part of their deposits is based on what’s called Net Demand and Time Liabilities (NDTL), ensuring that banks have a financial cushion, making them ready to cover any sudden surge in withdrawals by customers. Set under Section 24(2a) of the Banking Regulation Act (1949), it’s a critical move to maintain a bank’s health and the wider financial system’s stability.

The formula for Calculating SLR:

To figure out the Statutory Liquidity Ratio, banks must use the following formula:

SLR = (Liquid Assets / Net Demand and Time Liabilities) x 100

Here, ‘Liquid Assets‘ are those assets that are easily convertible to cash without losing value, and ‘Net Demand and Time Liabilities’ (NDTL) include the total of demand and time liabilities (deposits) of the bank with the public and other banks.

Example of SLR Calculation:

Let’s say a bank has:

  • Liquid Assets (such as government securities, cash, gold, etc.): ₹50,000 Crore
  • Net Demand and Time Liabilities (NDTL): ₹2,00,000 Crore

Using the formula:

SLR = (Liquid Assets / NDTL) x 100 SLR = (₹50,000 Crore / ₹2,00,000 Crore) x 100 SLR = 25%

This means the bank has maintained a Statutory Liquidity Ratio of 25%, indicating that it has set aside 25% of its NDTL in the form of liquid assets to meet its regulatory requirements.

How does the Statutory Liquidity Ratio work in Banks?

The Reserve Bank of India (RBI) dictates a key rule called the statutory liquidity ratio, or SLR for short. Each day, at close of business, banks must ensure they have a certain percentage of their net deposit liabilities readily available in liquid assets – that’s things like gold, cash, or government securities.

Banks report to the RBI every other Friday, giving them a rundown of their SLR standing. If a bank doesn’t meet the SLR requirements, it faces monetary penalties.

In India, the SLR shouldn’t dip below 23% or exceed 40%. If the RBI decides to up the SLR, banks suddenly find themselves needing to bulk up their reserves in these liquid assets. This action tightens the reins on how much money they can lend out. On the flip side, lowering the SLR means banks have extra cash to offer as loans, giving a boost to economic growth through increased credit flow.

Through the SLR, the RBI cleverly influences the nation’s financial throttle, accelerating or decelerating economic activity as needed by adjusting how much banks need to keep in their liquid reserves.

Adjusting the SLR Requirement:

As of August 9th, 2023, banks are instructed to maintain their Statutory Liquidity Ratio (SLR) at 18% of their deposits, in specific terms, their Net Demand and Time Liabilities (NDTL). However, keep in mind that this percentage isn’t set in stone. The Reserve Bank of India (RBI) holds the authority to tweak this requirement, adapting it according to the economic conditions or policy goals at any given time.

Components of Statutory Liquidity Ratio (SLR)

The Statutory Liquidity Ratio (SLR) comprises specific assets that financial institutions, usually banks, are required to hold as a percentage of their Net Demand and Time Liabilities (NDTL). The key components of SLR typically include:

  1. Liquid Assets

Liquid assets are one of the major things that the government uses to deal with an economic crisis. The assets include gold, cash reserves, treasury bills, government bonds, and Reserve Bank of India. The banks can invest in these assets listed under the Market Borrowing Programmes and Market Stabilisation Schemes.

  1. Net Demand and Time Liabilities (NDTL)

NDTL refers to demand deposits that commercial banks have to repay including savings accounts, current accounts, and demand drafts. These deposits do not allow immediate withdrawal thus strengthening the financial portfolio of the banks. This is why these are considered a safe investment to maintain the Statutory Liquidity Ratio (SLR).

Objectives of SLR

The following are the major objectives of SLR that make it one of the major components of the Indian banking and financial industry.

  • An SLR ratio ensures that the banks maintain a proportion of their assets in liquid form, typically government securities to meet short-term liquidity needs.
  • The SLR ratio safeguards the stability of the financial system by acting as a buffer against liquidity crises. The ratio offers a safety net for the banks ensuring that they have sufficient liquid assets to combat the economic crisis.
  • The monetary policy prescribed by the Reserve Bank of India influences the liquidity and credit conditions in the economy. Adjustments in SLR can be used as a tool to control credit expansion, interest rates, and overall monetary policy objectives.
  • The SLT helps to create a stable market for government securities by mandating banks to invest in them. This helps support the government’s borrowing program and ensures a reliable source of funds for public expenditure.

Types of Financial Institutions Required to Maintain an SLR

In India, RBI mandates the SLR for financial institutions via its annual monetary policy. The bank asks the following financial institutions to maintain a stable Statutory Liquidity Ratio (SLR):

  1. Regional Rural Banks (Local banks)
  2.  State, Urban, and Central Cooperative Banks
  3. National Banks
  4. Scheduled Commercial Banks

Impact of SLR Ratio on the Base Rate:

The SLR ratio impacts the base rate of banks in a great way. A higher SLR implies that a larger portion of banks’ funds is tied up in low-yielding government securities. This restricts them from lending to borrowers at competitive rates. Consequently, the base rate, which serves as a benchmark for lending rates, may be higher. Whereas, a lower SLR ratio offers a bank more flexibility to allot more funds for lending thus leading to a low base rate.

What factors are considered when determining the appropriate SLR level?

SLR is an important part of the Indian banking system as it protects the bank from bad economic days. The following factors are considered when determining the appropriate SLR levels as well:

  1. Rules and Objectives of Monetary Policy
  2. Current Economic Conditions
  3. Liquidity in the Financial System
  4. Government Debt Management
  5. Banking System Stability
  6. International Reserve Position
  7. Current Market Dynamics
  8. Government Fiscal Policy

What prompts the establishment of the Statutory Liquidity Ratio (SLR)?

The Statutory Liquidity Ratio (SLR) is one of the ways to strengthen the portfolio of commercial banks. The rate is set by the Reserve Bank of India and changes based on inflation and monetary policy. Maintaining an SLR rate protects the bank during the tough times at the time of liquidity crises, promotes stability in the banking sector, and facilitates effective monetary policy transmission.

What are the consequences of not maintaining SLR?

Not maintaining SLR can have serious consequences for Indian banks. The following are some of the major consequences that can happen if SLR maintenance rules are not followed:

  1. Failing to maintain the required Statutory Liquidity Ratio (SLR) exposes banks to liquidity risks. The SLT helps to combat a shortfall and a cover to meet depositors’ demands. Having a fixed SLR helps to avoid liquidity crises within the banking system.
  2. Banks having non-compliance with SLR requirements can lead to regulatory intervention. The RBI has the complete right to impose penalties and restrict a bank’s ability to undertake certain activities. The regulatory measures also help to ensure financial stability and safeguard the interests of depositors.
  3. SLR is a crucial tool for monetary policy transmission. If banks consistently fail to maintain the mandated SLR, then it can affect the monetary policy negatively. This can lead to complications in managing inflation, interest rates, and overall economic stability.

Importance of SLR in maintaining financial stability

The Statutory Liquidity Ratio (SLR) is extremely important to maintaining financial stability to combat market risks. The RBI asks the banks to hold a proportion of their assets in liquid and low-risk instruments, typically government securities. This requirement serves as a buffer against liquidity crises, assuring depositors of a bank’s ability to meet withdrawals. The RBI asks the bank to retain a percentage of their liabilities in secure assets to facilitate monetary policy transmission. It acts as a critical tool for regulators to balance liquidity, and credit creation by fostering a resilient financial environment.

Historical Overview of SLR in India

The Statutory Liquidity Ratio (SLR) in India was announced in 1962 by the central government. Initially, the bank prescribed the rate at 20% but the same was increased over the year citing the volatility of the market. The SLR was increased over the years, reaching 38.5% by 1991. Back in 1990, the government introduced Economic Reforms after which the SLR rate was lowered at up to 25% by 1997.

However, in 2008, the SLR was increased temporarily to combat the global financial crisis in 2008, recently, to align with the latest international developments and globalization the SLR has been reduced drastically to 18.25%.

Role of SLR in Government Debt Management

The SLR plays a very important role in managing the government debt. This rate defines the role of commercial banks in government securities. In India, the Reserve Bank determines the SLR rate for a financial year. To manage the debt efficiently, the RBI asks the commercial banks to maintain a certain percentage of their Net Demand and Time Liabilities (NDTL) in the form of SLR securities. Presently, the Statuary Liquidity Ratio is 18%. A high liquidity ratio ensures a stable market for government securities, facilitates fiscal policies and indirectly contributes to effective government debt management.

Frequently Asked Questions (FAQs)

  1. What is SLR full form?
    SLR stands for statutory liquidity ratio.
  2. What is the purpose of SLR in banking?
    The main purpose of SLR in banking is to protect the banks at the time of liquidity crisis.
  3. What is the present SLR rate?
    The present SLR rate is 18%.
  4. How is SLR different from Cash Reserve Ratio (CRR)?
    The RBI asks banks to maintain SLR by investing in government securities whereas for CRR one has to keep certain cash reserves with the central bank.
  5. What happens if a bank fails to maintain the SLR?
    If a bank fails to maintain the SLR then it can lead to a lending crisis at a time of financial and economic crisis.
  6. What is SLR and its objectives?
    SLR is a great tool to ensure financial stability at the time of economic crisis and helps control liquidity in the economy.
  7. What is the SLR and current SLR rate?
    SLRs are prescribed by RBI and remain fixed while the current SLR rate changes depending on the market conditions.

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