In Indian banking terms, statutory liquidity ratio (SLR) refers to the minimum reserve requirement that needs to be maintained by commercial banks in the nation. This term is used by the Indian government. The word 'statutory' indicates that it is mandatorily and legally required. The Reserve Bank of India (RBI) Act states that every commercial bank in India has to keep a certain amount of time deposits as well as demand deposits as liquid assets in its independent and own vault.
In the case of statutory liquidity ratio, these assets can be gold, cash, securities that are approved by the Indian government, etc. Apart from these assets, securities that are sanctioned under market stabilisation schemes (MSS) as well as market borrowing programmes, and treasury bills are included in the statutory liquidity ratio. Every bank must maintain this particular SLR as it assists in the process of increasing bank credit.
Statutory Liquidity Ratio (SLR) is typically defined as the ratio of a bank's liquid assets to a bank's net demand and time liabilities (NDTL).
SLR is one of the reserve ratios that has to be maintained by all banks as per the mandate of RBI. The other reserve ratio is known as the cash reserve ratio (CRR). A CRR refers to a particular percentage of a bank's overall deposits that needs to be kept with the Reserve Bank of India as a cash reserve.
A bank needs to maintain both CRR and SLR in order to function effectively in India according to the specifications of the RBI. Each banking institution is given customised instructions regarding the maintenance of SLR by the RBI. The RBI also offers regular updates regarding the classification of assets that will be treated as liquid assets under SLR.
Every nation has a certain monetary authority that is responsible for the functioning of banks. In our country, the Reserve Bank of India is the chief monetary authority and it works on a central level.
The main goal of the RBI is to make sure that prices are always stable in the nation without heavy fluctuations. Its primary responsibility is to create and operate a monetary policy. The monetary policy helps in administering the flow and supply of money for the purpose of attaining good growth in the economy. This is done by monitoring and managing various interest rates.
The RBI uses a set of monetary policy instruments and they include credit ceiling, statutory liquidity ratio, cash reserve ratio, bank rate policy, open market operations, credit authorisation scheme, repo rate, reverse repo rate, moral suasion, etc. Each of these instruments plays a very important role in controlling, managing, and coordinating the flow of money in the nation's economy.
As mentioned above, the monetary policy of the RBI requires that every bank maintains a particular set of liquid assets and these should be available at any particular point of time. Moreover, it is necessary that these assets are maintained in non-cash form. They can be bonds, precious metals, and other government-approved securities. The ratio of these liquid assets to the time and demand assets is the statutory liquidity ratio.
In India, every scheduled commercial bank, non-scheduled commercial bank, state as well as central cooperative banks, and primary (urban) co-operative banks are compulsorily required to keep a statutory liquidity ratio.
All banks must compulsorily provide a report or an update to the Reserve Bank of India every alternate Friday regarding their SLR status. In case any bank has not been successful in maintaining the specified SLR (as prescribed by the RBI), then the bank will be required to pay certain penalties.
The highest limit of SLR in India was 40%. On the other hand, the minimum limit of SLR is 0. As on 25 September 2017, the SLR rate in the country was 19.5%.
When there is a rise in the SLR, a bank is also restricted in terms of its leverage position. Hence, this rise in the SLR will enable a bank to release more funds into the economy and in turn, contribute towards the overall development of the economy.
The Statutory Liquidity Ratio plays a very prominent role in fixing the Base Rate of the Indian economy. In India, base rate refers to the minimum rate that is fixed by the Reserve Bank of India (RBI). This is the rate below which no bank can lend funds to borrowers. This rate is determined in order to make sure that there is transparency when banks lend funds to individuals in the credit market. The Base Rate also assists in making certain that banks offer low expenses of funds to any of their clients. It helps in minimising loan expenses for all borrowers.
The Base Rate in India is determined by the statutory liquidity ratio, cash reserve ratio, cost of borrowings, overhead costs, cost of deposits, and lots more.
Since the SLR has a role in determining the base rate of the country, the government of India and the Reserve Bank of India work together to make sure that the SLR is balanced. The statutory liquidity ratio is regularly monitored so that banks have a higher leverage and a better influencing aspect. The RBI also looks into how banks monitor their availability of funds for accepting deposits from customers and for giving as credits to customers.
The RBI is constantly working towards attaining financial inclusion. Hence, it is coming up with more and more strategies and techniques that can be applied in a cost-effective manner in order to make sure that banks have sufficient funds in their safe for ready credit. Earlier, banks use to avoid having any idle funds in their branches and hence, when there was any sudden and urgent requirement for credit or for any other form of funds, they failed as a lender at times.
In order to avoid this bad situation, the RBI makes it mandatory for banks to maintain a certain ratio of funds with the central bank of the nation. The RBI also wants banks to be very careful with the advances that are given by the government.
Many a time, the Reserve Bank of India itself engages in the reduction of the statutory liquidity ratio (SLR) of the country’s banks. There are many reasons for this cut in the SLR:
A reduction in the SLR rate according to the prevailing circumstances in the nation and across the world will assist in attaining financial stability. Financial stability is highly important in today’s ever-changing financial environment that sees constant change and fluctuations.
One may wonder what the accurate SLR level for any bank should be. It is commonly known that every bank functions by taking risks. Every bank has a certain component known as risk capital. This refers to the capital that is promised by the owners of any bank.
This risk capital serves as an excellent buffer against risks that are taken by banks. When a bank functions by taking so much risk, it is extremely important for them to treat this capital very cautiously. Hence, one can clearly decide that the correct SLR level would be the level of any bank’s risk capital. To make sure that a bank’s risk capital is absolutely secure, the bank should maintain its risk capital as the statutory liquidity ratio.
The fundamental justification for laying the Statutory Liquidity Ratio (SLR) by the Reserve Bank of India is cautiousness. In any financial activity, it is very important to be cautious and wary. Any bank in the world functions with a chief principle and that is to collect deposits from the public and then guarantee to offer customers with funds at par or more. However, this is a very risky activity for every bank. In order to protect the risk of each bank and to reduce their risk rate, the Reserve Bank of India makes it mandatory that each and every bank deploys at least one small part of its funds with the RBI so that its funds are safe in the hands of the most secure entity in the form of the most secure assets.
Many tend to wonder how the SLR helps in enhancing the economy. It is an amazing direct monetary instrument that has assisted the Indian government from time to time in selling its debt instruments as well as securities to banks. It has promoted and uplifted the debt management programme of the government. The programme is designed to help banks offer first-class loans to all sectors in the country.
The SLR also aims at minimising the holdings of commercial banks in government securities and slowly move towards private security holdings. The securities associated with SLR are securities that are free of risks.