Statutory Liquidity Ratio (SLR): Components, Objectives & Impact on Investors
The Reserve Bank of India maintains various instruments within its monetary policy to administer the Indian economy. It influences the prices of commodities, regulation of cash flow or money supply and many other factors of an economy.
Statutory liquidity ratio (SLR) is one of those financial instruments of RBI to maintain the solvency of banks. Read further to learn more about SLR.
What Is a Statutory Liquidity Ratio?
The meaning of statutory liquidity ratio is a mandatory reserve requirement that Indian commercial banks must maintain. They must maintain it through liquid assets like cash, gold, bonds, PSU and RBI approved securities.
RBI Act mandates commercial banks to maintain a percentage of their net demand and time liabilities (NDTL) as SLR. RBI determines this percentage of SLR to control the expansion of a commercial bank.
A change in this ratio controls the ability of a financial institution to inject money into our economy. Therefore, RBI increases it in the time of inflation to restrict banks and NBFCs from providing loans.
What Are the Components of Statutory Liquidity Ratio?
Statutory Liquidity Ratio comprises 2 components as follows -
1. Liquid Assets
Assets that are readily convertible into cash are called liquid assets. Gold, cash reserves, government bonds, treasury bills, and RBI approved securities fall under this category. Besides, these include eligible securities under Market Stabilisation Schemes and Market Borrowing Programmes.
2. Net Demand and Time Liabilities (NDTL)
This is the aggregate balance of demand and time deposits of the public that a bank holds. Demand deposits are liabilities that a bank must pay on demand, comprising current and savings accounts, demand drafts etc. In contrast, time liabilities such as fixed deposits do not allow you to withdraw deposits immediately. These have a maturity period before which you cannot access the deposit.
What Are the Objectives of Statutory Liquidity Ratio?
RBI fulfils the following objectives through the statutory liquidity ratio in India.
- SLR controls the bank to oversupply liquid money in the public’s hand.
- It controls the money supply and currency flow in our economy.
- In the time of inflation and deflation, it becomes a crucial instrument to tackle both.
- It ensures the solvency of all financial institutions by improving their monetary supply for timely credit requirements.
- SLR assists the government's debt management strategies.
- It encourages investments in government securities.
What Are the Types of Institutions That Needs to Maintain an SLR?
Following are the institutions that RBI obligates to maintain a statutory liquidity ratio.
- Scheduled Commercial Banks.
- Non-scheduled Commercial Banks.
- Co-operative Banks (both state and central).
- Urban Co-operative Banks (UCB)
- Small Finance Banks, Payments banks, and Local Area Banks
What Happens if an Institution Does Not Maintain Statutory Liquidity Ratio?
RBI levies an annual penalty of 3% over the bank rate for not maintaining liquid assets as SLR. Additionally, RBI charges a 5% fine if the bank fails to pay the penalty on the following working day.
What Is the Impact of Statutory Liquidity Ratio on Investors?
RBI uses SLR as a reference rate to determine the base rate, which is the minimum lending rate. No bank can lend money below this rate to the public. It is fixed to ensure clarity regarding lending and borrowing in the credit market.
The reserve requirement of RBI restricts banks’ lending capacity. Therefore, banks usually increase their lending rate to control the demand.
Differences Between Statutory Liquidity Ratio & Cash Reserve Ratio
| Statutory Liquidity Ratio | Cash Reserve Ratio |
|---|---|
| Banks are required to reserve liquid assets, which include cash, gold and government bonds as SLR. | Banks need to have only cash reserves with the Reserve Bank of India to maintain CRR. |
| Financial institutions earn returns on assets parked as SLR. | In contrast, financial institutions do not earn returns on cash parked as CRR |
| SLR works as a tool to control the credit expansion of a bank. | Whereas, RBI uses CRR as a tool for controlling liquidity in banks. |
| Banks need to maintain the liquid assets by themselves. | On the other hand, banks must maintain CRR with the Reserve bank. |
Frequently Asked Questions
Do NBFCs in India need to maintain SLR?
In India, the NBFCs (deposit-taking and non-deposit taking) are not bound to maintain an SLR.
How is SLR in India calculated?
The formula to calculate SLR is = {liquid assets / Net Demand & Time Liabilities (NDTL)} x 100
What happens if SLR increases?
RBI increases SLR to control excess liquidity and inflation in our economy. An increase in SLR restricts the bank’s lending capacity. Consequently, banks charge a higher interest rate on loans to control the demand. This is how RBI successfully prevents banks from injecting money into the market.
What is SLR full form in banking in India?
The full form of SLR in banking is “statutory liquidity ratio”.