The Reserve Bank of India (RBI) is India’s primary monetary regulator in charge of all financial institutions. RBI makes and implements monetary policies to look over price stability, aid in economic growth, control interest rates, etc. The Statutory Liquidity Ratio (SLR) is a monetary policy instrument that RBI uses for these purposes.
SLR stipulates that commercial banks in India have to maintain a minimum portion of their net demand and time liabilities in cash, gold and government-approved bonds. As of 11 March 2022, Indian banks were holding 29% of their deposits in government bonds due to an absence of strong credit growth. (1)
Read along to know the function of this monetary policy tool.
What does Statutory Liquidity Ratio mean?
It refers to the mandatory reserve requirements for commercial banks in India. Banks must maintain a minimum percentage of deposits as government-approved liquid assets. SLR is the ratio of these assets to net demand and time liabilities (NDTL). Under Section 24 and Section 56 of the Banking Regulation Act, all banks must maintain the SLR before providing credit.
The statutory part implies that the law mandates financial institutions to follow SLR. Banks must keep their reserves in assets like gold, cash and government securities. These secured assets help protect their reserves and provide an interest income, though it is quite low.
As per the latest monetary policy announced on 10 February 2022, the SLR rate is 18% (2). An increase in this rate would restrict how much money banks can inject into the economy. On the other hand, a decrease would allow them greater freedom to offer loans. RBI can increase the SLR rate to a maximum of 40%.
Components of the Statutory Liquidity Ratio
The following are the various components of SLR in more detail.
- Liquid assets: Cash, gold and government securities constitute the main assets used by banks. Most of them keep SLR as central government bonds and treasury bills due to their reasonable rate of returns. Besides this, they can invest in market stabilisation schemes (MSS), market borrowing programs and state development loans (SDL). Foreign banking companies also need to maintain such deposits.
- Net demand and time liabilities: NDTL is the aggregate of demand deposits, time deposits and other liabilities owed to the public minus deposits held by other banks. Demand deposits consist of all liabilities that a bank is liable to pay on demand, including current deposits, overdue fixed deposits, demand drafts and savings deposits.
Time deposits are those that a bank must pay upon maturity, and depositors cannot access them anytime. Staff security deposits, fixed deposits and time liabilities part of savings deposits are some of the examples of such deposits.
Significance of SLR in the Indian economy
It is mandatory for banks to maintain their liquid assets in proportions assigned by the SLR rate. The primary purpose of keeping liquid assets as mandated by SLR is to limit the risk exposure of banks. All banks must provide a guarantee to customers when accepting public deposits. Thus, RBI requires them to protect their funds and minimise risks by investing in the assets that are most secured.
The Statutory Liquidity Ratio is a monetary policy instrument of RBI and an essential tool for the Indian Government for its debt management program. SLR can be used to regulate the flow of funds in the economy, manage price stability, credit growth, bank viability, etc. It also promotes investments in government debt instruments and securities.
When the SLR rate rises, banks can infuse less money into the economy due to low liquidity and a decrease in inflation. Thus, low SLR reduces borrowings offered by institutions and helps to control inflation. Conversely, low SLR rates cause economic growth as banks are less hesitant to offer loans.
SLR rates affect different parts of the economy as it serves as a base rate determined by RBI. A decrease in SLR rates would reduce the minimum lending rates of banks. As a result, they would be able to provide lower interest rates, and more people would apply for home loans.
Purposes of the SLR rate in the economy
The following are the various purpose and usage of SLR in the country’s economy:
- It protects banks from over-liquidation and makes sure that they have sufficient funds.
- RBI can raise the SLR to curb bank credit and control inflation. With a decrease in SLR ratio, home loans and other credit increases to address an economic recession.
- It helps to keep money and inventory under control. RBI mandates that banks do not own a large amount of idle cash to prevent formation of idle stock.
- With SLR being a statutory mandate, the government ensures that it can easily sell its bonds to banks, which helps with its debt management program.
- It makes sure that a specific portion of fixed deposits is safe and available for customers.
All Indian banks, whether scheduled commercial banks, primary co-operative banks or state co-operative banks, must keep a certain portion of their reserves as per the Statutory Liquidity Ratio. Banks have to report their compliance to this mandate every 14 days, failing which they have to pay certain penalties to RBI.