The Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold, or other approved securities. It is basically the reserve requirement that banks must keep before providing credit to customers.
In India, the Reserve Bank of India (RBI) always determines the percentage of SLR. The maximum limit of SLR is 40%. The Statutory Liquidity Ratio (SLR) is prescribed by Section 24 (2A) of the Banking Regulation Act of 1949.
The Reserve Bank of India (RBI) fixes the SLR in order to control liquidity expansion. SLR regulates credit growth in India. The SLR is determined as a percentage of total demand and time liabilities. Time liabilities refer to the liabilities that the commercial banks are liable to repay to the customers after an agreed period. Demand liabilities are customer deposits which are repayable on demand.
The ‘Statutory Liquidity Ratio’ or ‘SLR’ term is used by the Indian government. The word ‘statutory’ indicates that it is mandatory and legally required.
The SLR is usually used to control inflation and fuel growth by decreasing or increasing the money supply.
Significance of Statutory Liquidity Ratio (SLR)
To control bank credit, changing SLR would change the bank credit availability. In the case of the solvency of commercial banks, it will help repay stakeholders.
The government uses the SLR to regulate inflation and encourage growth. Increasing the SLR will control inflation in the economy while decreasing the SLR will cause growth in the economy.
SLR has helped the government to sell its securities or debt instruments to banks. Several banks will be keeping their SLR in the form of government securities as it will earn them an interest income. By making banks invest in government securities, the government has enough financial resources.
The RBI can increase the SLR to control inflation, suck liquidity out of the market, to tighten the measure to safeguard the customers’ money. A decrease in the SLR rate is done to encourage growth.
Why is the SLR fixed?
The SLR is fixed for several reasons. A few uses of mandating SLR are as follows:
- To control the expansion of bank credit. By changing the level of SLR, the Reserve Bank of India can increase or decrease bank credit expansion.
- Ensuring the solvency of commercial banks
- By reducing the level of SLR, the RBI can increase liquidity with commercial banks, resulting in increased investment. This is done to fuel growth and demand.
- Compelling commercial banks to invest in government securities like government bonds
If any Indian bank fails to maintain the required level of the Statutory Liquidity Ratio, it becomes liable to pay a penalty to the Reserve Bank of India (RBI). 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.
However, 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.
SLR Formula
SLR indicates the minimum percentage of deposits that a bank has to maintain in the form of gold, cash or other approved securities before providing credit to customers.
Banks must have a particular portion of their Net Demand and Time Liabilities (NDTL) in the form of cash, gold, or other liquid assets by the end of the day. The ratio of these liquid assets to the demand and time liabilities is called the Statutory Liquidity Ratio (SLR).
SLR rate = (liquid assets / (demand + time liabilities)) × 100%
This percentage is fixed by the Reserve Bank of India. The maximum limit for the SLR was 40% in India. Following the amendment of the Banking Regulation Act (1949) in January 2017, the floor rate of 20.75% for SLR was removed.
To know the current Statutory Liquidity Ratio (SLR), click here.