Statutory liquidity ratio

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Statutory liquidity ratio (SLR) refers amount that the commercial banks require to maintain in the form of gold or govt. approved securities before providing credit to the customers. Here by approved securities we mean, bond and shares of different companies. Statutory Liquidity Ratio is determined and maintained by the Reserve Bank of India in order to control the expansion of bank credit.

Determination of SLR

It is determined as percentage of total demand and time liabilities. Time Liabilities refer to the liabilities, which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon and demand liabilities are such deposits of the customers which are payable on demand. example of time liability is a fixed deposits for 6 months, which is not payable on demand but after six months. example of demand liability is deposit maintained in saving account or current account, which are payable on demand through a withdrawal form of a cheque.

Usage of SLR

SLR is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold,cash or other approved securities.Thus, we can say that it is ratio of cash and some other approved liabilities(deposits). It regulates the credit growth in India.

The liabilities that the banks are liable to pay within one month's time, due to completion of maturity period, are also considered as time liabilities. The maximum limit of SLR is 40% and minimum limit of SLR is 22% In India, Reserve Bank of India always determines the percentage of SLR. There are some statutory requirements for temporarily placing the money in government bonds. Following this requirement, Reserve Bank of India fixes the level of SLR. At present, the minimum limit of SLO that can be set by the Reserve Bank is 22% AS ON 5 August 2014.[1] A reduction of SLR rate looks eminent to support the credit growth in India.

Objectives of SLR

The main objectives for maintaining the SLR ratio are the following:

  • to control the expansion of bank credit. By changing the level of SLR, the Reserve Bank of India can increase or decrease bank credit expansion.
  • to ensure the solvency of commercial banks.
  • to compel the commercial banks to invest in government securities like government bonds.

If any Indian bank fails to maintain the required level of Statutory Liquidity Ratio, then it becomes liable to pay penalty to Reserve Bank of India. The defaulter bank pays penal interest at the rate of 3% per annum above the Bank Rate, on the shortfall amount for that particular day. But, according to the Circular, released by the Department of Banking Operations and Development, Reserve Bank of India; if the defaulter bank continues to default on the next working day, then the rate of penal interest can be increased to 5% per annum above the Bank Rate. This restriction is imposed by RBI on banks to make funds available to customers on demand as soon as possible. Gold and government securities (or gilts) are included along with cash because they are highly liquid and safe assets.

The RBI can increase the SLR to contain inflation, suck liquidity in the market, to tighten the measure to safeguard the customers money. In a growing economy banks would like to invest in stock market, not in government securities or gold as the latter would yield less returns. One more reason is long term government securities (or any bond) are sensitive to interest rate changes. But in an emerging economy interest rate change is a common activity.

Statutory liquidity ratio is the amount of liquid assets such as precious metals (gold) or other approved securities, that a financial institution must maintain as reserves other than the cash. The statutory liquidity ratio is a term most commonly used in India.

The SLR is commonly used to contain inflation and fuel growth, by increasing or decreasing it respectively. This counter acts by decreasing or increasing the money supply in the system respectively. Indian banks’ holdings of government securities (Government securities) are now close to the statutory minimum that banks are required to hold to comply with existing regulation. When measured in rupees, such holdings decreased for the first time in a little less than 40 years (since the nationalisation of banks in 1969) in 2005–06.

While the recent credit boom is a key driver of the decline in banks’ portfolios of G-Sec, other factors have played an important role recently.

These include:

  1. Interest rate increases.
  2. Changes in the prudential regulation of banks’ investments in G-Sec.

Most G-Sec held by banks are long-term fixed-rate bonds, which are insensitive to changes in interest rates. Increasing interest rates have eroded banks’ income from trading in G-Sec.

Recently a huge demand in G-Sec was seen by almost all the banks when RBI released around 108000 crore rupees in the financial system. This was by reducing CRR, SLR & Repo rates. This was to increase lending by the banks to the corporates and resolve liquidity crisis. Providing economy with the much needed fuel of liquidity to maintain the pace of growth rate. However the exercise became futile with banks being over cautious of lending in highly shaky market conditions. Banks invested almost 70% of this money to rather safe Govt securities than lending it to corporates.

Value and formula[edit]

The quantum is specified as some percentage of the total demand and time liabilities ( i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities which are accruing in one months time due to maturity) of a bank.

SLR rate = (liquid assets / (demand + time liabilities)) × 100%

This percentage is fixed by the central bank. The maximum and minimum limits for the SLR are 40% and 25% respectively in India.[2] Following the amendment of the Banking regulation Act(1949) in January 2007, the floor rate of 25% for SLR was removed. Presently, the SLR is 22%.

Difference between SLR and CRR[edit]

Both CRR and SLR are instruments in the hands of RBI to regulate money supply in the hands of banks that they can pump in economy

SLR restricts the bank’s leverage in pumping more money into the economy. On the other hand, CRR, or cash reserve ratio, is the portion of deposits that the banks have to maintain with the Central Bank to reduce liquidity in banking system. Thus CRR controls liquidity in banking system while SLR regulates credit growth in the country.

The other difference is that to meet SLR, banks can use cash, gold or approved securities whereas with CRR it has to be only cash. CRR is maintained in cash form with central bank, whereas SLR is money deposited in govt. securities. CRR is used to control inflation.

See also[edit]

Cash reserve ratio

References[edit]

Further reading[edit]