Statutory Liquidity Ratio
To manage the Indian economy, the RBI employs a variety of monetary policy measures. It impacts commodity prices, the management of cash flow or supply of money, and many other aspects of an economy.
The SLR (statutory liquidity ratio) is one of the financial instruments used by the Reserve Bank Of India to ensure bank solvency. Continue reading to learn more about what is statutory liquidity ratio and its components.
Statutory Liquidity Ratio Meaning
The Statutory Liquidity Ratio (SLR) is the minimum proportion of deposits that commercial banking institutions must keep in their own vaults as cash, gold assets, or securities approved by the government. The banking institutions must keep these deposits, not with the RBI (Reserve Bank of India).
The SLR is defined as the ratio of a bank's liquid assets to its NTDL (net demand and time liabilities). The SLR is an essential tool in the RBI's monetary policy because it helps manage cash flow in the economy and preserves the bank's stability.
The present SLR rate is 18%; however, the RBI has the right to boost it to 40%. The greater the commercial banks' SLR, the greater the limits on their liquidity and ability to pump funds into the economy. The apex authority imposes a penalty if a banking institution fails to satisfy the SLR requirement.
According to the Banking Regulation Act of 1949, the following lending institutions are required to keep an SLR:
- Scheduled Commercial Banks
- State Co-operative Banks
- Urban Co-operative or UCB
- Central Co-operative Banks
- Local Area Banks
Statutory Liquidity Ratio Formula
SLR = 100% * (liquid assets / (demand + time liabilities)).
Example
As an example, consider ABC Bank. The bank's liquid assets are $20 million. NTDLs are worth Rs 200 million to the bank (demand liabilities and net time).
To calculate ABC Bank's SLR with the above-mentioned assets, we will apply the following formula:
SLR = LA / NTDL
SLR = (Rs 40,000,000 / Rs 400,000,000)*100
SLR = 10%
Hence, the SLR of the bank is 10%.
How does the Statutory Liquidity Ratio Work?
The RBI sets the statutory liquidity ratio. The banks should maintain the SLR limit, and it should be inspected at the conclusion of every working day. Following that, banks must keep a predetermined part of their NDTL, like cash and gold, in liquid assets.
Every bank is required to provide an update or statement to the RBI on their SLR status on alternate Fridays. If a bank fails to adhere to the needed SLR, it will be penalized.
In India, the lowest SLR limit is 23%, and the maximum level is 40%.
If the RBI raises the SLR limit, banks must enhance their liquid asset reserves to maintain the SLR; this limits the ability of banks to loan money and infuse credit into the country's economy. When the SLR limit is cut, banks have more funds to lend, thus increasing credit lending; this supports economic credit development.
Therefore, the RBI can manage monetary policy through SLR.
Why Are There Reductions In SLR
The RBI cuts the SLR of Indian banks on a regular basis. Some of the causes behind this are as follows:
- It ensures that banking institutions work with higher authority without influence from other sources.
- The statutory liquidity ratio is gradually reduced by the RBI in order to maintain the economy's base lending rate. Because the base lending rate dramatically impacts the overall lending process, the Reserve Bank of India takes special care to ensure that the process of lending runs seamlessly across all institutions. The RBI regularly examines and modifies the base lending rate since it is vulnerable to frequent changes due to market volatility.
- Many banks do not always modify how they operate, which makes the entire procedure repetitive. As a result, the Reserve Bank Of India lowers the SLR rate. With the lower SLR, the bank staff is also motivated to achieve better performance each month and encouraged to develop initiatives to boost the operations and processes of every branch.
- The RBI may reduce the statutory liquidity rate from time to time in order to improve the overall financial health of the country's economy. When each bank is committed to achieving an exact SLR specified by the Reserve Bank of India, it can achieve its objectives more efficiently. They develop, design, and implement corrective procedures while complying with the RBI's strict criteria; this contributes to the total economy automatically improving and progressing toward a higher position on the international financial market.
Based on the current scenario in the country and worldwide, lowering the SLR rate will aid in achieving financial stability, which is critical in today's ever-changing economic environment, which sees constant modification and alterations.
What Is The Distinction Between The CRR And The SLR?
The RBI's monetary policy is divided into the CRR and the SLR. The statutory liquid ratio is known as SLR, while the cash reserve ratio is known as CRR. SLR is the percentile ratio of liquid assets deposits like gold, PSU bonds, security bonds, and many more.
The current rates for both are:
CRR=4%
SLR=18%
The critical distinctions between CRR and SLR are:
- SLR comprises liquid assets such as gold, bonds, and securities, whereas CRR solely has cash reserves.
- The bank retains SLR funds. However, CRR monies are held by the RBI.
- Banks gain interest in SLR. However, there's no interest in CRR.
- CRR manages liquidity, whereas SLR regulates credit expansion.
Conclusion
The SLR is a crucial criterion for banking institutions to follow and comply with the RBI's laws and guidelines. The SLR also assures that commercial banks have the necessary funds in the event of widespread deposit redemptions.