What is Statutory Liquid Ratio (SLR)?

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Statutory Liquid Ratio (SLR)

The Reserve Bank of India (RBI) wields a crucial tool to manage the Indian financial system: the Statutory Liquidity Ratio (SLR). This ratio dictates a minimum percentage of a bank's deposits (Net Demand and Time Liabilities, or NDTL) that must be held in highly liquid assets like cash, gold, or government securities. Unlike the Cash Reserve Ratio (CRR) deposited with the RBI, SLR assets are managed by the banks themselves. The current SLR in India stands at 18%.

How the SLR Functions

Banks are mandated to maintain a specific portion of their NDTL in readily available assets by the end of each business day. The SLR determines the minimum ratio of these liquid assets to the total NDTL. This ratio empowers the RBI to influence the money supply in the economy.

Impact of SLR on Money Supply

  1. Tightening the Tap: An increased SLR reduces the portion of deposits available for lending. This restricts the money circulating in the economy, potentially curbing inflation.
  2. Stimulating Growth: Conversely, a lowered SLR allows banks to lend more, potentially boosting economic activity.

Components of Statutory Liquidity Ratio

According to Sections 24 and 56 of the Banking Regulation Act 1949, all scheduled commercial banks, local area banks, primary (urban) co-operative banks (UCBs), state co-operative banks, and central co-operative banks in India must maintain the Statutory Liquidity Ratio (SLR). Below are the key components of the SLR.

Liquid Assets

Liquid assets are those that can be easily converted into cash. These include:

  1. Gold
  2. Treasury bills
  3. Government-approved securities
  4. Government bonds
  5. Cash reserves
  6. Securities eligible under Market Stabilization Schemes
  7. Securities under Market Borrowing Programmes

Net Demand and Time Liabilities (NDTL)

NDTL represents the total demand and time liabilities (deposits) held by the banks.

  1. Demand Deposits: These are liabilities that must be paid on demand, such as current deposits, demand drafts, overdue fixed deposits, and the demand liabilities portion of savings bank deposits.
  2. Time Deposits: These are deposits repayable on maturity, not immediately withdrawable by the depositor. Examples include fixed deposits (FDs), the time liabilities portion of savings bank deposits, and staff security deposits. Bank liabilities also encompass call money market borrowings, certificates of deposit, and investment deposits in other banks.

Objectives of Statutory Liquidity Ratio

Preventing Over-Liquidation

The SLR helps prevent banks from becoming overly liquid, which could happen if the Cash Reserve Ratio increases and banks urgently need funds. By implementing SLR, the RBI maintains control over bank credit, ensuring commercial banks remain solvent and invest in government securities.

Regulating Bank Credit Flow

The RBI adjusts the SLR to manage bank credit flow. During inflation, the SLR is increased to restrict bank credit. Conversely, during a recession, the SLR is lowered to boost bank credit.

SLR vs CRR: What are the Differences?

Both the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) are integral parts of monetary policy, but they serve different purposes and have distinct characteristics. The table below outlines their differences:

Statutory Liquidity Ratio (SLR)Cash Reserve Ratio (CRR)
Banks must maintain reserves of liquid assets, including cash and gold.Banks are required to hold only cash reserves with the RBI.
Banks earn returns on funds kept as SLR.Banks do not earn returns on funds held as CRR.
SLR controls bank leverage for credit expansion.CRR regulates liquidity in the banking system.
Securities for SLR are kept with the banks themselves as liquid assets.Cash reserves for CRR are maintained with the RBI.

Does SLR impact investors?

The Statutory Liquidity Ratio (SLR) doesn't directly set borrowing costs for investors. However, it can indirectly influence lending rates. Here's how:

  1. Limited Lending Pool: A higher SLR shrinks the pool of money banks can lend.
  2. Potential Rate Increase: To maintain profitability, banks might raise lending rates to compensate for the reduced lending pool. 
  3. Investor Impact: This potential rise could lead to higher borrowing costs for investors seeking loans.

Banks must report their Net Demand and Time Liabilities (NDTL) to the RBI every two weeks for SLR calculation and adherence. This ensures they maintain enough liquid assets (cash, gold, government securities) to meet customer withdrawal demands.

Failing to meet the SLR triggers penalties like:

  1. Initial Non-Compliance: 3% annual penalty above the bank rate.
  2. Continued Default: Penalty escalates to 5%.
  3. These measures ensure banks prioritize liquidity, safeguarding depositors' access to their funds.

FAQs

  • What is the current SLR in India?

    As of January 2024, the current SLR in India is 18%. This means banks must hold at least 18% of their deposits in highly liquid assets.

  • What happens if a bank fails to maintain the SLR?

    The RBI imposes penalties on banks that don't maintain the required SLR. These penalties start at 3% above the bank rate and can increase to 5% for continued non-compliance. This incentivizes banks to keep enough liquid assets on hand.

  • What is the formula for SLR?

    The formula for calculating the Statutory Liquidity Ratio (SLR) is:

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

  • What happens if SLR increases?

    1. Reduced Lending Capacity: Banks have less money available for lending to businesses and individuals.
    2. Potential Rise in Interest Rates: To maintain profitability, banks might raise lending rates to compensate for the reduced lending pool. This could affect loan rates for mortgages, car loans, etc.
    3. Tighter Money Supply: With less money circulating in the economy, inflation might be controlled.
  • Why do banks maintain SLR?

    Banks maintain SLR primarily for two reasons:

    1. Liquidity Management: SLR ensures banks have enough readily available cash to meet customer withdrawal demands, promoting financial system stability.
    2. RBI Regulation: The RBI sets the SLR as a tool to manage the money supply and influence economic activity.
  • Who decides the SLR?

    The Reserve Bank of India (RBI) has the authority to set the Statutory Liquidity Ratio (SLR). This policy decision is based on various factors like the current economic situation and inflation level

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