Statutory Liquidity Ratio

Statutory Liquidity Ratio

Statutory Liquidity Ratio

One of the main functions of the Reserve Bank of India (RBI) is to control the supply of credit as well as the cost of it. The RBI mandates that every bank is required to maintain a specific liquid reserve. This may be in the form of money or gold. This is known as the Statutory Liquidity Ratio (SLR). The term statutory indicates that it is mandatory and legally essential. This article explores the ratio and its importance in the financial economy of India.

SLR

Every country has its own particular monetary authority which is responsible for the working of banks across that country. In India, this authority is the RBI. It is considered the chief monetary authority and works on a central level. The main goal of the RBI is to ensure the stability of the prices in the nation and prevent large fluctuations. It creates and operates monetary policies around this objective.

It uses such monetary policy instruments for this very purpose. One of the many policies that the RBI uses is the Statutory Liquidity Ratio (SLR). Such financial policies help in administering the flow and the supply of money to attain positive growth in the economy, which is achieved by monitoring and managing various interest rates.

Objectives

Statutory Liquidity Ratio has mainly two objectives at its core.

  • To prevent over liquidating:
    • One of the main objectives of SLR is to prevent commercial banks from over-liquidating. This may occur in the absence of the ratio. It may even happen when the Cash Reserve Ratio increases and when banks require funds. To have control over a bank’s credit, the RBI has an SLR regulation employed. This helps the RBI to ensure that there are no solvencies in commercial banks and that the banks invest in government securities.
  • To monitor the flow of bank credit:
    • SLR is in action to increase or decrease the flow of credit offered by banks in the country’s economy. The RBI raises the limit of SLR in times of inflation and reduces the same during the recession.

The Working

At the end of a day, it is essential that every bank have a minimum portion of their Net Demand and Time Liabilities (NDTL) in the form of cash or gold or any other liquid asset. Net Demand refers to the capacity at which a bank can withdraw money from its accounts immediately. Whereas, Time Liabilities refers to when the bank has to stay on hold to redeem its liabilities. Statutory Liquidity Ratio can be defined as the ratio of the liquid assets of the bank to the NDTL. This ratio, amongst many other tools, is essential and instrumental to ensure the solvency of banks and the proper flow of money in the country’s economy.

The RBI has the authority to set a maximum of Statutory Liquidity Ratio at 40% per annum. However, the current Statutory Liquidity Ratio is maintained at 19.25% per annum. As the ratio increases, the ability to inject money into the economy of a bank would be restricted. The RBI holds the responsibility of regulating the supply of money and ensuring the stability of prices for the proper functioning of the country’s economy. Statutory Liquidity Ratio can be seen as one of those many monetary policies that the RBI uses for this very purpose.

Components

The functioning of the Statutory Liquidity Ratio has been prescribed in Section 24 and Section 56 of the Banking Regulation Act of 1949. It essentially states that all commercial banks working in India are required to maintain the ratio. Therefore, to understand the proper working of the Statutory Liquidity Ratio, it is necessary to know about the components of the SLR.

Liquid Assets

Assets such as gold, treasury bills, government-approved securities, government bonds and cash reserves can be easily converted into cash. Securities eligible under the Market Stabilisation Scheme (MSS) and the Market Borrowing Programmes are also considered as assets.

Net Demand and Time Liabilities (NDTL)

Net Demand refers to the capacity at which a bank can withdraw money from its accounts immediately. Whereas, Time Liabilities refers to when the bank has to stay on hold to redeem its liabilities. Together, it depicts the total demand and liabilities in deposits that are held by public banks and with other banks. All the liabilities which a bank has to pay on demand is called Demand Deposits. These deposits could include demand drafts, current deposits, demand liabilities portion of savings bank deposits and balances in overdue fixed deposits.

Time deposits, on the other hand, consists of deposits that are required to repay on maturity or where the depositor cannot withdraw the money immediately. Therefore, an individual is required to wait out their lock-in tenure in order to access the funds. A few examples of this are fixed deposits, staff security deposits and time liabilities portion of savings bank deposits. The liabilities of a bank comprises of a certificate of deposits, call money market borrowings and investment deposits in other banks.

SLR Limit

The RBI has the authority to set a maximum of Statutory Liquidity Ratio at 40% per annum. The minimum ratio for SLR is 0. However, the current Statutory Liquidity Ratio is maintained at 19.25% per annum.

Impact of SLR

The Statutory Liquidity Ratio is one of the most crucial reference rates that the RBI uses to determine the base rate. Base rate can be defined as the minimum lending rate of a bank. Accordingly, no bank will be able to lend fund below this specific rate. The rate has been fixed to ensure the transparency of the credit market in terms of borrowing and lending. This rate also plays a vital role in helping banks to cut down their costs of borrowing in order to be able to extend affordable loans.

The RBI ensures that a particular portion of the deposits are safe and are always accessible to users to redeem when it imposes a reserve requirement. However, this also restricts the lending capacity of a bank. Therefore, there has to an increase in lending rates to keep the demand in control.

Implications of Non-Maintenance

Every bank in India, regardless of being a state cooperative bank, scheduled commercial bank, central cooperative bank or primary cooperative banks, is required to maintain Statutory Liquidity Ratio according to the guidelines set by the RBI. In order to compute and maintain SLR, banks are required to report their latest NDTL to the RBI every fortnight.

In case a commercial bank fails to do so or maintain the SLR, the RBI has to power to levy a penalty of 3% annually over the bank rate. The penalty will be increased to a scale of 5% if the bank defaults on the next working day as well. This would ensure that commercial banks have enough ready cash in liquid form that could be accessed by customers who need them.

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