The Reserve Bank of India mandates every bank should have a specific liquid reserve in the form of cash or gold. It is called Statutory Liquidity Ratio ( SLR ).
How does Statutory Liquidity Ratio work?
Every bank must have a minimum portion of their Net Demand and Time Liabilities (NDTL) in the form of cash, gold or other liquid assets by the day’s end. The ratio of these liquid assets to the demand and time liabilities is called as the Statutory Liquidity Ratio. The Reserve Bank of India has the authority to increase this ratio up to 40%. The increase in this ratio constricts the ability of the bank to inject money into the economy.
In India, the Reserve Bank of India is responsible for regulating the supply of money and stability of prices to run the economy. Statutory Liquidity Ratio is one of its many monetary policies for the same. SLR (among other tools) is instrumental in ensuring the solvency of the banks and money flow in the economy.
Components of Statutory Liquidity Ratio
Section 24 and Section 56 of the Banking Regulation Act 1949 mandates all commercial banks in India to maintain SLR. It becomes pertinent to know in detail about the components of the SLR as mentioned below.
a. Liquid Assets
These are assets one can easily convert into cash – like gold, treasury bills, govt-approved securities, government bonds and cash reserves. Additionally, it also consists of securities, eligible under Market Stabilization Schemes and those under the Market Borrowing Programmes.
b. Net Demand and Time Liabilities (NDTL)
NDTL refers to the total demand and time liabilities (deposits) that is held by the banks of public and with other banks. Demand deposits consist of all liabilities which the bank needs to pay on demand. They include current deposits, demand drafts, balances in overdue fixed deposits and demand liabilities portion of savings bank deposits.
Time deposits consist of deposits that need to repay on maturity, where the depositor can’t withdraw money immediately. Instead, he must wait until the lock-in tenure is over to access the funds. Fixed deposits, time liabilities portion of savings bank deposits and staff security deposits are some examples. The liabilities of a bank include call money market borrowings, certificate of deposits and investment deposits in other banks.
c. SLR Limit
The SLR has an upper limit of 40% and a lower limit of 23%.
Objectives of Statutory Liquidity Ratio
a. To curtail the commercial banks from over liquidating:
This can happen in the absence of SLR, when the Cash Reserve Ratio goes up and the bank is in dire need of funds. RBI employs SLR regulation to have control over the bank credit. It helps to ensure that there is solvency in commercial banks and assures that banks invest in government securities.
b. To increase or decrease the flow of bank credit:
The Reserve Bank of India raises SLR to control the bank credit during the time of inflation. Similarly, it decreases the SLR during the time of recession to increase the bank credit.
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 so as 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. To keep this demand in control, there needs to be an increase in 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 – shall maintain 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.
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