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What is Statutory Liquidity Ratio and Why is it Important?
21 June 2022
The Reserve Bank of India (RBI), the country’s central bank, oversees and manages the monetary policy of India. It has laid down several rules and regulations for banks so that the monetary policy is streamlined and inflation, liquidity and credit growth are controlled within limits. Banks governed by the RBI must maintain the stipulated Statutory Liquidity Ratio (SLR) at all times to comply with the rules specified by the RBI.
Let’s understand the Statutory Liquidity Ratio meaning and its different aspects. Read on!
What is a Statutory Liquidity Ratio (SLR)?
Section 24 (2A) of the Banking Regulation Act, 1949 gives the definition of Statutory Liquidity Ratio. The Section explains Statutory Liquidity Ratio as a specified minimum percentage of deposits each bank should maintain before it offers credit products to its customers. Banks can maintain the specified SLR in gold, cash or other securities with monetary value.
Features of Statutory Liquidity Ratio
Some of the highlighting features of the SLR are as follows:
The SLR is the monetary reserve that banks are required to maintain, which helps the RBI regulate the credit growth in the economy.
Banks reserve the SLR themselves, not with the RBI.
Every commercial bank, primary co-operative banks in urban areas, local area banks and State and Central co-operative banks have to maintain the stipulated SLR
Non-maintenance of the SLR incurs penalties; thus, banks continuously maintain the specified SLR percentage.
The Statutory Liquidity Ratio limit is fixed by the RBI and reviewed periodically. The RBI can increase or decrease the limit to manage the monetary policy.
What are the Components of the Statutory Liquidity Ratio (SLR)?
To understand the Statutory Liquidity Ratio meaning completely, you need to understand the various components that constitute this ratio. Here’s a look at such components in detail:
Liquid assets of a bank are those securities that can be converted to cash instantly. Examples include Treasury Bills (T-Bills), Government bonds, cash reserves, gold and Government-approved securities
Net Demand and Time Liabilities (NDTL)
The different types of deposits offered by banks fall under this category. Demand deposits are those that have no lock-in period. Customers can demand to withdraw such deposits whenever they need. Examples include savings account, current accounts, demand drafts, balance in matured fixed deposits, etc. Time deposits, on the other hand, are those that have a specific maturity date. Such deposits are held by the bank till they mature. Examples include fixed deposits, recurring deposits, etc. Other liabilities of the bank would include certificates of deposits (CD), money-market borrowings, deposits in other banks, etc.
How does Statutory Liquidity Ratio (SLR) Work?
The RBI stipulates the SLR. The SLR limit should be maintained daily and checked at the end of each working day. After that, banks must maintain the specified portion of their Net Demand and Time Liabilities (NDTL) in the form of liquid assets.
If the RBI increases the Statutory Liquidity Ratio limit, banks are required to increase their liquid asset reserve to maintain the SLR. This reduces the banks’ ability to lend money and inject credit into the economy. On the other hand, if the SLR limit is reduced, banks get additional funds to lend and their credit lending increases. This promotes credit growth in the economy.
Thus, using SLR, RBI can control monetary policy.
How is the Statutory Liquidity Ratio Calculated (SLR)?
The calculation of the SLR is quite simple. All you need are the two components of the SLR, and you can find out how to calculate the ratio. Here’s the formula for SLR calculation –
Formula to calculate Statutory Liquidity Ratio
SLR = (Liquid assets / Net Demand and Time Liabilities) x 100
For instance, if a bank has Rs. 10 lakh crores in liquid assets and Rs. 300 lakh crores in NDTL, the SLR would be calculated as follows –
As mentioned earlier, the RBI specifies and reviews the SLR. Currently, the Statutory Liquidity Ratio limit for 2022 is 18%. This means that banks should maintain 18% of their NDTL in the form of liquid assets. For example, if the NDTL of a bank is Rs. 100 lakh crores, it should maintain Rs. 18 lakh crores in liquid assets.
There is also an upper limit to the SLR beyond which the RBI cannot exceed the rate. This limit is 40%.
Objectives of Statutory Liquidity Ratio (SLR)
The SLR is an important tool in RBI’s kitty for various monetary policies. Moreover, the SLR also stabilizes the banking industry in India. Some of the important objectives of the SLR are as follows –
The SLR helps the RBI to control credit growth in the economy. The RBI can increase or decrease the SLR depending on the change needed in credit growth.
Through the SLR, the RBI also makes it mandatory for banks to invest in Government securities that form a part of their liquid assets. This gives the Government the funds needed for its expenses.
Through SLR, the RBI controls the supply of money in the economy.
The SLR also ensures the financial stability of banks. This is because when banks are mandated to hold a liquid reserve, they can use this reserve to pay their creditors in dire cases.
Besides the SLR, the Cash Reserve Ratio (CRR) is also an important metric for banks. The CRR is a specified percentage of the Net Demand and Time Liabilities (NDTL) that a bank should maintain in the form of cash reserves.
The RBI also specifies the CRR. The CRR helps banks pay their customers in the immediate liquidation of their deposits. Banks can maintain the CRR reserve in their vaults or deposit it with the RBI.
Though the SLR and the CRR seem similar, they have differences. Here’s a look at the significant differences between SLR and CRR:
Statutory Liquidity Ratio
Cash Reserve Ratio
The SLR helps the RBI control the growth of credit in the country
The CRR helps banks with the reserves needed to pay their depositors in the case of redemption pressure
Banks maintain the SLR within themselves
Banks can maintain the CRR themselves or also deposit the reserve with the RBI
The SLR can be maintained in the form of liquid assets, including cash
The CRR is maintained only in the form of cash reserves
The SLR helps the RBI design and maintain its monetary policy
The CRR has no effect on the monetary policy of the country
The current SLR is 18%
The current CRR is 4%
What Could Happen if SLR is Poorly Maintained?
Banks are required to maintain the specified SLR and report the same to the Reserve Bank of India regularly. In the case of non-maintenance of the specified SLR, the RBI levies a penalty on the bank.
This penalty is levied at 3% + the bank rate. If the bank continues to default in maintaining the SLR on the next working day, the penalty rate increases to 5%. Therefore, in the case of poor maintenance of the SLR, banks are fined, which affects their profitability.
Impact of Statutory Liquidity Ratio on the Economy
The SLR affects the overall economy. Here’s how:
An increased SLR restricts the bank’s lending capacity. This restricts credit growth in the economy.
The SLR also influences the base rate of lending, i.e., the minimum rate at which banks would offer loans. This promotes transparency in loan interest rates across different banks.
The ratio helps maintain banks’ financial solvency, which makes the banking sector more stable.
SLR helps the Government to manage its debts by selling its securities to banks.
The Statutory Liquidity Ratio (SLR) is an essential criterion for banks to comply with the rules and guidelines laid down by the RBI. For customers, too, the SLR ensures that banks have the required funds in the case of mass redemptions of deposits. So, understand what SLR stands for and how it impacts the economy.
FAQs on Statutory Liquidity Ratio
Q1. Does SLR also include the applicable CRR that banks should maintain?
Ans:No, the SLR and the CLR are independent ratios. Banks have to maintain each ratio independently. So, if the SLR is 18% and CRR is 4%, banks should have a separate SLR reserve of 18% of their Net Deposit and Time Liabilities and another 4% for maintaining their CRR.
Q2. Is there any specific percentage for banks to buy Government securities to maintain the SLR?
Ans:No, there is no specific percentage for buying Government securities to constitute the SLR reserve.
Q3. Is gold a mandatory part of the SLR?
Ans:No, gold is not mandatory. However, banks often use gold as a part of their cash reserves.
Q4. Can the SLR change?
Ans:Yes, the SLR can be increased or decreased by the RBI depending on the monetary policy the RBI wants to adopt.
Q5. If the RBI wants to rein in inflation, how would the SLR be changed?
Ans:To control inflation, RBI increases the SLR. This requires banks to maintain a higher amount of reserve which, in turn, restricts their lending capacity and reduces the availability of funds in the hands of the household.
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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