The Reserve Bank of India (RBI) utilises the Statutory Liquidity Ratio or SLR as a financial tool to assess the liquidity available with banks. SLR mandates that banks invest a particular percentage of their assets in specific federal and state government securities.
What is SLR or Statutory Liquidity Ratio?
Commercial banks are required to invest a percentage of their total deposits in liquid assets under the SLR. The Reserve Bank of India has identified liquid assets in which banks must invest to maintain their SLR.
As per RBI, liquid assets may be maintained:
- in cash, or
- in gold, valued at a price not exceeding the current market price, or
- in the form of unencumbered investments in approved securities
The term “approved securities” refers to securities issued by the central government or any state government as well as other securities that the RBI may specify from time to time. The SLR status of securities issued by the Government of India and state governments is determined by the RBI.
Here are some SLR securities that have been approved:
- Government of India securities that have been dated
- Government of India’s Treasury Bills
- Dated securities published by the Government of India under the market borrowing programme and the Market Stabilization Scheme from time to time
- State Development Loans (SDLs), which are short-term loans granted by the state as part of its market borrowing programme
- Any other instrument that the Reserve Bank of India specifies
The Statutory Liquidity Ratio is calculated in terms of percentage. The statutory liquidity ratio rate at present is 18 per cent. RBI has specified 40% as the maximum SLR restriction. Further, one must know that SLR is calculated as a percentage of the bank’s total deposits. The ratio of a bank’s liquid assets to its net demand and time obligations is another way to define the SLR. (NDTL).
The aggregate of a bank’s savings account, current account, and fixed deposit balances is known as NDTL or Net Demand and Time Liabilities. Banks must retain 18 per cent of their total deposits with the RBI in the form of liquid securities. Unlike in the case of CRR, banks earn money on government securities it invests in under the broader area of Statutory Liquidity Ratio.
SLR and CRR must be maintained by all banks supervised by the RBI.
Objectives of SLR or Statutory Liquidity Ratio
While the primary goal of monetary policy tools like the CRR and SLR is to maintain liquidity, they also serve a variety of other purposes:
- When the RBI raises the CRR, one of the key goals is to prevent commercial banks from selling their liquid assets.
- The RBI uses the concept of SLR to regulate loan flow in banks.
- SLR promotes commercial banks to invest in government assets in some ways.
- Banks’ solvency is also ensured by requiring them to invest a percentage of their deposits in government securities.
- SLR is a monetary policy tool, but it also assists the government in the sale of a large number of securities. As a result, SLR supports the government’s debt management programme as well as the RBI’s monetary policy.
Uses of Statutory Liquidity Ratio
RBI is in charge of managing cash flows, inflation, and pricing levels in the country as the country’s principal monetary authority.
RBI has a variety of tools at its disposal to carry out its functions effectively. Repo rate, reverse repo rate, bank rate, marginal standing facility, open market operations, moral suasion, SLR, CRR, and a few others are only a few examples.
SLR also assists the RBI in controlling inflation in a variety of ways. Raising the SLR encourages banks to invest more in government securities, reducing the amount of cash in circulation, which in turn, leads to reduced inflation. Maintaining cash flow in the economy is easier when you do the opposite. Reducing the SLR gives banks additional liquidity, which, in turn, creates the right situation for the economy to grow and expand.
How does Statutory Liquidity Ratio work?
In the Indian economy, RBI uses SLR to manage credit expansion and inflation. When the SLR rises, institutions can lend less, resulting in less liquidity in the economy and less upward pressure on inflation. The SLR also specifies the number of liquid assets that financial institutions must retain on hand in the event of a depositor demand. SLR is a monetary mechanism that encourages investment in government debt instruments and financial institution assets. As a result, funds are invested in the safest assets, as the approved securities are risk-free.
SLR also has an impact on other aspects of the economy. You may benefit from these alterations in some circumstances. SLR is also one of the reference rates used to set the base rate for loans. Lenders are more likely to provide lower interest rates when the SLR reduces, but when the SLR increases, the interest rate is more likely to climb as well.
The Bottom Line
Understanding the SLR in depth allows you to gain a better understanding of the Indian economy’s fundamental components as well as how the interest on your home loan works.