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by 5paisa Research Team Last Updated: 2023-06-28T12:58:02+05:30
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In the context of Indian banking, the statutory liquidity ratio (SLR) pertains to the mandatory reserve requirement imposed by the Indian government on commercial banks. As outlined in the RBI's Act, this requirement stipulates that all commercial banks operating in India must maintain a specific portion of their demand deposits and time deposits as the liquid assets within their own secure vault. The term "statutory" emphasises that this obligation is legally binding.
This post will highlight everything you must know about what is SLR in detail. So, keep reading it till the end. 
 

What is Statutory Liquidity Ratio - SLR?

The Statutory Liquidity Ratio (SLR), commonly referred to as SLR, represents the minimum proportion of the deposits that all the commercial banks must hold in the form of gold, cash, and also other securities. It is important to note that such deposits are maintained and managed by the banks, and the RBI doesn't hold them.

Why is the Statutory Liquidity Ratio - SLR fixed?

●    To curb the growth of bank credit.
●    To safeguard the financial stability of the commercial banks.
●    To enforce banks to allocate funds towards government securities such as bonds.
●    To stimulate economic growth and demand by reducing the SLR, thereby increasing liquidity available within the commercial banks.
 

Reserve Ratios to be Maintained by Banks in India

The Statutory Liquidity Ratio (SLR) is among the mandated reserve ratios, and all banks are required to maintain it according to the regulations of the Reserve Bank of India (RBI). The Cash Reserve Ratio is another reserve ratio. The CRR denotes a specific percentage of the total deposits of the bank that must be held with the RBI as the cash reserve.
In order to operate effectively in India, a bank is obligated to manage both the SLR and CRR in accordance with the guidelines set by the RBI. All the banking institutions receive customised instructions from the RBI for the SLR's maintenance. Additionally, the RBI provides regular updates on the categorisation of the assets that qualify under liquid assets as per the SLR requirement.
 

Background Regarding Statutory Liquidity Ratio (SLR)

In every country, there exists a specific monetary authority responsible for overseeing the operations of banks. The RBI serves as the primary monetary authority operating at the central level.
Therefore, the primary objective of the Reserve Bank of India is to ensure price stability in the country by minimising significant fluctuations. One of its key responsibilities is formulating and implementing monetary policy. This policy governs the supply and regulation of money with the aim of achieving robust economic growth. To accomplish this, the RBI closely monitors and manages different interest rates.
The Reserve Bank of India employs a range of monetary policies, including statutory liquidity ratio, credit ceilings, bank rate policy, cash reserve ratio, credit authorisation scheme, open market operations, reverse repo rate, repo rate, moral suasion, and more. These instruments control, manage and coordinate the money flow within the country's economy.
 

Goals of the Monetary Policy Created by the Reserve Bank of India

●    Its objective is to maintain price stability, which is crucial for fostering favourable economic growth.
●    It strives to skilfully manage the increase in bank credit and monetary supply, ensuring that the output of any bank is not negatively affected. Moreover, this measure makes sure that banks can meet their seasonal credit necessities.
●    The monetary policy aims to regulate the accumulation of inventories and money. Excessive accumulation of inventories and money leads to outdated stocks and the emergence of financially distressed units. The RBI emphasises the importance of avoiding idle funds to prevent banks from facing financial distress.
 

Types of Institutions that are Asked to Maintain an SLR

In India, as per the statutory liquidity ratio meaning all scheduled and non-scheduled commercial banks, primary (urban) co-operative banks, and state and central co-operative banks must maintain a statutory liquidity ratio (SLR).

How Does a Statutory Liquidity Ratio (SLR) Works in Banks?

Every alternate Friday, all banks are mandated to submit a report or update to the RBI concerning their SLR status. If any bank fails to maintain the prescribed Statutory Liquidity Ratio set by the RBI, it will be subjected to penalties.
When the SLR increases, banks face limitations on their leverage position. Consequently, this increase in the SLR allows banks to raise the funds in the nation's economy, thus contributing to overall economic development.
 

Impact of Statutory Liquidity Ratio on the Base Rate

The Statutory Liquidity Ratio (SLR) plays a significant role in establishing the Indian economy's Base Rate. In our country, the base rate is the least rate set by the Reserve Bank of India, and below this rate, no other banks are allowed to lend funds to borrowers. The determination of India's Base Rate considers factors such as the cash reserve ratio, statutory liquidity ratio, overhead costs, cost of borrowings, cost of deposits, and more.
Given the SLR's influence on the base rate, the RBI along with the Indian government collaborate to ensure a balanced Statutory Liquidity Ratio. Regularly monitoring the statutory liquidity ratio is conducted to enable banks to have high leverage with a more significant impact. Moreover, RBI also examines how banks manage their fund availability to accept deposits from various customers and extend credit to them.
 

Components of Statutory Liquidity Ratio

The Statutory Liquidity Ratio (SLR) consists of two components, which are as follows:

1.    Liquid Assets: Liquid assets are the ones that get converted into cash easily. This category includes cash reserves, gold, treasury bills, government bonds, and securities approved by the Reserve Bank of India (RBI). It also encompasses eligible securities present under the Market Borrowing Programmes and Market Stabilisation Schemes.
2.    Net Demand and Time Liabilities (NDTL): NDTL represents the combined balance of time and demand deposits the public holds in a bank. Demand deposits refer to liabilities a commercial bank must repay upon demand, including current accounts, savings accounts, and demand drafts. On the other hand, time liabilities, like fixed deposits, don't allow immediate withdrawal of funds. These deposits have a specified maturity period, and funds cannot be accessed until that period elapses.
 

Difference Between SLR & CRR

Statutory Liquidity Ratio

Cash Reserve Ratio

Gold, cash, and government bonds are examples of liquid assets that must be held in reserve by banks as SLR.

To maintain CRR, banks just need to maintain cash reserves with the RBI.

Financial institutions earn returns on assets fixed as Statutory Liquidity Ratio.

However, financial institutions do not get returns on the cash stored as CRR.

The banks must maintain a liquid asset on their own.

Banks, on the contrary, are required to have CRR on file with the RBI.

SLR functions like a tool to limit a bank's ability to provide loans.

While the RBI utilises CRR as a tool to manage bank liquidity.

Reduction in the Statutory Liquidity Ratio

On many occasions, the Reserve Bank of India itself takes measures to reduce the statutory liquidity ratio (SLR) of our country's banks. So, there are several reasons behind this reduction in the SLR:

●    The most important reason is to provide banks with greater autonomy and minimise interference from other institutions. By lowering the SLR, banks can operate with more authority and flexibility.
●    The reduction in SLR is aimed at maintaining a favourable position for the economy's base rate too. As this base rate significantly impacts the lending process, the central bank ensures careful management to ensure smooth lending operations across all other banks.
●    Another motive behind decreasing the SLR is to address the issue of certain banks operating with a monotonous approach during specific times of the year. By reducing the SLR, the RBI intends to eliminate this pattern and encourage banks to operate with more commitment and dedication.
●    The RBI may also lower the SLR to bring about overall economic and financial improvements. 
Adjusting the SLR's rate in accordance with existing situations within the nation and global markets contributes to achieving financial stability. Given the constant changes and fluctuations in the financial landscape, maintaining financial constancy is crucial in today's dynamic financial environment.
 

How Does One Decide the Correct SLR Level?

The question arises as to what the appropriate level of SLR should be for a bank. It is well-known that banks operate by assuming risks, and they have a component called risk capital. So, this risk capital represents the capital committed by a bank's owner and serves as a vital cushion against the risks undertaken by the bank.
Given the significant risks involved in banking operations, handling this capital with utmost caution becomes crucial. Hence, it becomes evident that the appropriate Statutory Liquidity Ratio level should align with the bank's risk capital level. By maintaining the statutory liquidity ratio equivalent to the bank's risk capital, the bank ensures the utmost security of their risk capital.
 

What Is the Exact Rationale for Imposing the Statutory Liquidity Ratio (SLR)?

The Reserve Bank of India along with the other central banks utilize the Statutory Liquidity Ratio (SLR) as a tool for monetary policy to control credit flow in the economy and maintain the financial system's stability. The fundamental goal of implementing the SLR is to preserve the banks' liquidity and solvency while fostering the financial system's overall stability.

What Happens If SLR Is Not Maintained?

In India, every type of bank, including scheduled commercial banks, state co-operative banks, co-operative central banks, and primary co-operative banks, is obligated to maintain the Statutory Liquidity Ratio (SLR) in accordance with the Reserve Bank of India’s approved guidelines. If a commercial bank fails to maintain the stipulated SLR, the RBI imposes an annual penalty of 3% over the bank rate. Furthermore, failure to rectify the shortfall by the next working day incurs an additional penalty of 5%. These penalties serve as a deterrent to ensure that commercial banks always have sufficient cash reserves readily available to meet the demands of their customers.

Current Repo Rate and Its Impact

In addition to the Statutory Liquidity Ratio (SLR), the RBI uses the repo rate and reverse repo rate as other metrics for economic regulation. Whenever the RBI adjusts these rates, it affects various sectors of the economy, although the impacts may vary. Some sectors may benefit from a rate hike, while others may experience losses. Notably, significant changes in reverse repo rates can have a considerable impact on major loans such as home loans.
You must note that a reduction in the repo rate by the RBI does not automatically result in lower Equated Monthly Instalments (EMIs) for home loans. The interest rates may not necessarily decrease either. For the EMIs to reduce, the lending bank must also lower its "Base Lending" rate.
 

Conclusion

Banks worldwide function as institutions that securely hold public deposits and provide returns. However, this function has inherent risks, requiring banks to be cautious. The Reserve Bank of India (RBI) justifies the policy of the statutory liquidity ratio (SLR) by ensuring the solvency of banks and protecting the public's money.
Now that you know what is statutory liquidity ratio, many individuals wonder how the SLR contributes to the enhancement of the economy. It serves as an effective monetary instrument that has assisted the Indian government in selling its debt instruments and securities to banks. This, in turn, has facilitated the government's debt management program, enabling banks to provide high-quality loans to various sectors across the country.
Additionally, the SLR aims to minimise commercial banks' holdings in government securities and gradually shift towards holding more private securities. These securities associated with the SLR are considered low-risk investments.
 

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Frequently Asked Questions

The statutory liquidity ratio (SLR) was created to help Indian financial institutions maintain liquidity. SLR also aids in preserving the nation's inflation and credit flow.

Maintaining the base rate, also known as the minimum rate, at which Indian lenders can grant loans to their clients is one of the key functions of SLR. The RBI and other Indian banks are more transparent thanks in large part to SLR. The RBI makes the decision about the SLR.

SLR is the overall ratio lenders in India must maintain between their net assets and time liabilities.

The prevailing statutory liquidity ratio (SLR) stands at 18.00%.

SLR is the ratio that the lenders are required to always keep between time obligations and net assets. The Reserve Bank of India (RBI) makes SLR decisions.

The Reserve Bank of India uses both SLR and CRR as distinct mechanisms that are not related to one another.