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The Reserve Bank of India, under the supervision of the Indian Government’s Ministry of Finance, is the ultimate regulatory body of financial activities in the country. The RBI is responsible for dealing with multiple monetary activities, including monitoring banks, currency, foreign exchange, government funding, inflation, etc.
As part of its monetary policies, the RBI has introduced various ratios that help maintain the country’s financial stability and the SLR is one such ratio. In today’s article, we will discuss what is SLR and its significance.
India’s monetary policy
The full form of SLR is Statutory Liquidity Ratio. Before diving into SLR, let’s discuss briefly on India’s monetary policies.
Monetary policies are essential for any country to regulate financial activities and maintain economic stability. In India, monetary policies are formed by the RBI, and these policies are a significant part of the RBI Act of 1934. As per provisions in the act, a six-member committee was formed in 2016, called the “Monetary Policy Committee”, to create these policies and review their impact on the economy.
India’s monetary policy includes various instruments, like the repo rate, bank rate, CRR, SLR, marginal standing facility (MSF), etc., to cover different financial aspects of the economy.
What is the statutory liquidity ratio?
The statutory liquidity ratio is a number set by the RBI that suggests the minimum reserves banks must maintain in their custody at all times. These reserves consist of liquid assets, such as cash, gold and government securities.
The current statutory liquidity ratio in India is at 18%. This indicates that 18% of a bank’s total deposits (net of time and demand deposits) must be reserved as a statutory requirement and cannot be used to lend credits to borrowers.
Banks will have possession of these reserves, and they need not maintain them with the RBI. However, a periodic return on every alternate Friday must be submitted to the RBI showing the details of deposits and SLR. If the bank’s SLR falls below the required limit, such banks will be penalised at 3% p.a. over the bank rate, calculated on the SLR deficit amount. If the SLR deficit continues in the upcoming reports, the RBI can increase fines up to 5%.
The maximum and minimum SLR percentage limits are 40 and 0, respectively, between which RBI decides the prevailing rates.
Elements of SLR
SLR must be held in the form of liquid assets, either in cash, gold, government securities, or a combination of all three.
Government securities include bonds, treasury bills, dated securities and other approved instruments.
A commercial bank can calculate its SLR using the formula,
SLR = (Total of liquid assets / Net of time and demand deposits) * 100.
Take the example of a bank with the following numbers:
Cash for SLR: ₹12 crores
Gold worth ₹15 crores
Other government securities worth ₹12 crores
NDTL (Net demand and time liabilities) of the bank: ₹200 crores
The bank’s SLR = [(12+15+12)/200] * 100
SLR = 19.5%, which is above the rate of 18%.
The ₹39 crores held by the bank as reserves, in this case, must not be used for credit lending operations.
Why does the RBI use SLR?
- Reserves maintained to fulfil SLR requirements have a significant role in providing a cushion to banks. These reserves act as a buffer when banks undergo financial uncertainties and crises.
- SLR is also an important tool for the RBI to control the economy’s money flow and liquidity, which is required to handle economic downfalls like inflation and recession. When the inflation rate is high, banks increase the SLR rate to reduce the loans lent, thereby decreasing the money flow in the economy.
- By allowing banks to maintain SLR in the form of government securities, the RBI promotes investment in government instruments, increasing the government’s income.
Impact of SLR on consumers
SLR has a direct impact on the base rate and interest rate, which affects a consumer’s borrowing capacity.
RBI uses SLR as one of the fundamental components while deciding the base rate, which is the minimum interest rate banks must charge on loans.
Besides, SLR has a significant bearing on the interest rates charged by individual banks. When SLR increases, the money available to the bank to lend decreases, causing an increase in the interest rate. Similarly, when SLR reduces, the money available increases, causing a lower interest rate. It works on the basic economic principle of supply and price moving in opposite directions.
CRR vs SLR
CRR stands for Cash Reserve Ratio. Like SLR, CRR is also a monetary policy by the RBI about maintaining reserves. However, CRR is purely maintained in cash. Another differentiator is that banks must keep CRR with RBI, unlike SLR, which they maintain in their own custody.
Bottomline
SLR is a vital component of India’s monetary policy. It is a rate determined by the RBI, at which all commercial banks must maintain liquid reserves in the form of cash, gold or government securities.
SLR plays a huge role in RBI’s monitoring of money in the economy and controlling financial lows like inflation.
FAQs
CRR, like SLR, serves the same purpose of controlling money matters in the economy. The only difference is that CRR is maintained as cash with the RBI, while SLR includes all liquid assets maintained in the bank itself.
Demand and time liabilities are deposits banks hold. Demand liabilities are deposits which have to be paid back on the customer’s request, while time deposits are held in the bank until maturity and cannot be redeemed upon the customer’s desire.
NDTL is the base number for banks to calculate both CRR and SLR. Both reserve ratios are calculated and maintained as a percentage of NDTL.
The RBI uses monetary policies like CRR, SLR and other rates to control inflation. The repo rate is another popular instrument used by the RBI to handle the downsides of inflation. The repo rate is the rate at which commercial banks can borrow money from the RBI when in need.
SLR includes investing in government securities. Banks earn interest on such securities. In CRR, however, the money kept with the RBI does not help banks earn any interest.
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