Statutory liquidity ratio (SLR) is the Indian government term for reserve requirement that the commercial banks in India require to maintain in the form of gold, government approved securities before providing credit to the customers. Statutory Liquidity Ratio is determined by Reserve Bank of India maintained by banks in order to control the expansion of bank credit.
Contents
The SLR is determined by a 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. An example of time liability is a six month fixed deposit which is not payable on demand but only after six months. An example of demand liability is a deposit maintained in saving account or current account that is payable on demand through a withdrawal form such as a cheque.
The SLR is commonly used to control 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 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.currently it is 21.05 percent.
Usage
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 liability (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 0 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. However, as most banks currently keep an SLR higher than required (>26%) due to lack of credible lending options, near term reductions are unlikely to increase liquidity and are more symbolic.
The SLR is fixed for a number of reasons. The chief driving force is increasing or decreasing liquidity which can result in a desired outcome. A few uses of mandating SLR are:
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 control inflation, suck liquidity in the market, to tighten the measure to safeguard the customers' money. Decrease in SLR rate is done to encourage growth. 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.
Value and formula
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 were40% and 25% respectively in India. 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 20.50%.
Difference between Statutory Liquidity Ratio and Cash Reserve Ratio
Both Cash Reserve Ratio (CRR) and SLR are instruments in the hands of RBI to regulate money supply in the hands of banks that they can pump into the 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.