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Statutory Liquidity Ratio (SLR) is typically defined as the ratio of a bank’s liquid assets to a bank’s net demand and time liabilities (NDTL).
SLR is one of the reserve ratios that has to be maintained by all banks as per the mandate of RBI. The other reserve ratio is known as the cash reserve ratio (CRR). A CRR refers to a particular percentage of a bank’s overall deposits that needs to be kept with the Reserve Bank of India as a cash reserve.
A bank needs to maintain both CRR and SLR in order to function effectively in India according to the specifications of the RBI. Each banking institution is given customised instructions regarding the maintenance of SLR by the RBI. The RBI also offers regular updates regarding the classification of assets that will be treated as liquid assets under SLR.
Background Regarding Statutory Liquidity Ratio (SLR)
Every nation has a certain monetary authority that is responsible for the functioning of banks. In our country, the Reserve Bank of India is the chief monetary authority and it works on a central level.
The main goal of the RBI is to make sure that prices are always stable in the nation without heavy fluctuations. Its primary responsibility is to create and operate a monetary policy. The monetary policy helps in administering the flow and supply of money for the purpose of attaining good growth in the economy. This is done by monitoring and managing various interest rates.
The RBI uses a set of monetary policy instruments and they include credit ceiling, statutory liquidity ratio, cash reserve ratio, bank rate policy, open market operations, credit authorisation scheme, repo rate, reverse repo rate, moral suasion, etc. Each of these instruments plays a very important role in controlling, managing, and coordinating the flow of money in the nation’s economy.
Goals of the Monetary Policy Created by the Reserve Bank of India
- It works towards keeping prices stable as this helps in achieving good economic development.
- It aims to increase bank credit as well as monetary supply skillfully so that any bank’s output does not get affected. This measure also helps in making sure that all banks have the ability to meet seasonal credit requirements.
- The monetary policy works towards controlling the stocking of money and inventories. Unlimited stocking of money and inventories result in outdated stocks and these, in return, result in the creation of sick units. In order to prevent a bank from becoming a sick unit, the RBI insists that no bank has idle funds.
- The RBI, through its monetary policy, works towards making banks flexible in nature. This measure is taken specifically to promote variety, idea generation, independence among bank staff, and a free and friendly environment for both customers as well as employees. The central monetary institution interferes in any bank’s operations only when it is absolutely required.
- The monetary policy also aims at raising the output and performance of fixed investments of banks. This is done by restricting fixed investments that are not necessary for a bank.
As mentioned above, the monetary policy of the RBI requires that every bank maintains a particular set of liquid assets and these should be available at any particular point of time. Moreover, it is necessary that these assets are maintained in non-cash form. They can be bonds, precious metals, and other government-approved securities. The ratio of these liquid assets to the time and demand assets is the statutory liquidity ratio.
Types of Institutions that are Asked to Maintain an SLR
In India, every scheduled commercial bank, non-scheduled commercial bank, state as well as central cooperative banks, and primary (urban) co-operative banks are compulsorily required to keep a statutory liquidity ratio.
How Statutory Liquidity Ratio (SLR) Works in Banks
All banks must compulsorily provide a report or an update to the Reserve Bank of India every alternate Friday regarding their SLR status. In case any bank has not been successful in maintaining the specified SLR (as prescribed by the RBI), then the bank will be required to pay certain penalties.
The highest limit of SLR in India was 40%. On the other hand, the minimum limit of SLR is 0. As on 25 September 2017, the SLR rate in the country was 19.5%.
When there is a rise in the SLR, a bank is also restricted in terms of its leverage position. Hence, this rise in the SLR will enable a bank to release more funds into the economy and in turn, contribute towards the overall development of the economy.
Impact of Statutory Liquidity Ratio on the Base Rate
The Statutory Liquidity Ratio plays a very prominent role in fixing the Base Rate of the Indian economy. In India, base rate refers to the minimum rate that is fixed by the Reserve Bank of India (RBI). This is the rate below which no bank can lend funds to borrowers. This rate is determined in order to make sure that there is transparency when banks lend funds to individuals in the credit market. The Base Rate also assists in making certain that banks offer low expenses of funds to any of their clients. It helps in minimising loan expenses for all borrowers.
The Base Rate in India is determined by the statutory liquidity ratio, cash reserve ratio, cost of borrowings, overhead costs, cost of deposits, and lots more.
Since the SLR has a role in determining the base rate of the country, the government of India and the Reserve Bank of India work together to make sure that the SLR is balanced. The statutory liquidity ratio is regularly monitored so that banks have a higher leverage and a better influencing aspect. The RBI also looks into how banks monitor their availability of funds for accepting deposits from customers and for giving as credits to customers.
The RBI is constantly working towards attaining financial inclusion. Hence, it is coming up with more and more strategies and techniques that can be applied in a cost-effective manner in order to make sure that banks have sufficient funds in their safe for ready credit. Earlier, banks use to avoid having any idle funds in their branches and hence, when there was any sudden and urgent requirement for credit or for any other form of funds, they failed as a lender at times.
In order to avoid this bad situation, the RBI makes it mandatory for banks to maintain a certain ratio of funds with the central bank of the nation. The RBI also wants banks to be very careful with the advances that are given by the government.
Impact of SLR on the Investor
The Statutory Liquidity Ratio acts as one of the reference rates when RBI has to determine the base rate. Base rate is nothing but the minimum lending rate. No bank can lend funds below this rate. This rate is fixed to ensure transparency with respect to borrowing and lending in the credit market. The Base Rate also helps the banks to cut down on their cost of lending to be able to extend affordable loans.
When RBI imposes a reserve requirement, it ensures that a certain portion of the deposits are safe and are always available for customers to redeem. However, this condition also restricts the bank’s lending capacity. In order to keep the demand in control, the bank will have to increase its lending rates.
What happens if SLR is not maintained?
In India, every bank – scheduled commercial bank, state cooperative bank, central cooperative banks, and primary co-operative banks – is required to maintain the SLR as per the RBI guidelines. For computation and maintenance of SLR, banks have to report their latest net demand and time liabilities to RBI every fortnight (Friday).
If any commercial bank fails to maintain the SLR, RBI will levy a 3% penalty annually over the bank rate. Defaulting on the next working day too will lead to a 5% fine. This will ensure that commercial banks do not fail to have ready cash available when customers demand them.