What Is Statutory Liquidity Ratio?

What Is Statutory Liquidity Ratio?

Statutory Liquidity Ratio or SLR refers to the minimum reserve all commercial banks are mandatorily/legally required to maintain in the form of cash, gold, or government securities before offering credit to customers. It is the ratio between the bank’s liquid assets and net demand and time liabilities (NDTL). This rate affects the credit rates of the banks and influences home loan rates when you avail of an instant home loan. A high SLR means the banks have less money for commercial operations and hence, less money to lend out. This leads to a rise in the home loan interest rates. Low SLR means commercial banks have more liquidity leading to a fall in home loan interest rate

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Main Components of the Statutory Liquidity Ratio

There are mainly three major components of SLR:

Liquid Assets

These are assets that one can easily convert into cash. These include gold, govt.-approved securities, cash reserves, treasury bills, and government bonds, Securities issued under market stabilization scheme and securities issued under market borrowing programmes come under this. 

Net Demand Liabilities

This is like a borrower’s current and saving bank account from which they can withdraw money at any time of the day.

Time Liabilities

These liabilities are like fixed deposit bank accounts; banks cannot immediately withdraw money from them.

How is SLR Calculated?

The formula for calculating the statutory liquidity ratio is given below:

Statutory Liquidity Ratio = LA / NTDL

Where,

LA stands for liquid assets

NTDL represents Net time-based and demand liabilities

Impact of SLR

  1. The impact of SLR on any economy is great as SLR regulates the flow of funds in the economy and fixes the base rate. The base rate is the rate below which the commercial banks cannot lend funds to the borrowers. The base rate, therefore, promotes transparency over the lending and borrowing business.
  2. The statutory liquidity ratio also helps to make sure that some portion of deposits would always remain safe, and would be readily provided to the deposit holders if they redeem the deposits in the future in the event of failure of the financial system. For the SLR to remain competitive, commercial banks must report their net time and demand liabilities on a fortnight basis.
  3. If the commercial banks falling under the central banks (here RBI) fail to comply with the statutory liquidity ratio, then the commercial bank must pay a fine of three percent along with the bank rate. Additional defaults can result in further 5 percent penalty on commercial banks.
  4. When RBI increases SLR, the commercial banks are required to maintain a larger amount in the form of liquid assets held by them. So, the liquidity of commercial banks to lend out in the form of loans decreases. As a result, liquidity in the economy decreases which helps control price hikes or inflation. Due to high prices, people lower their consumption of goods, which results in a slowdown in economic growth.
  5. When RBI decreases the SLR, banks have less money tied up in liquid assets held by them. Thus, they can afford to lend more, which leads to increased liquidity in markets. While such a situation can help promote economic growth through increased consumption, it can also lead to inflation.

Uses of a Statutory Liquidity Ratio 

  • The RBI can increase or decrease bank credit expansion by changing the level of SLR as and when required.
  • It helps in assuring the financial safety and solvency of commercial banks.
  • By decreasing the level of SLR, the RBI can increase liquidity with commercial banks. As a result, it increases investment. This helps to increase growth and demand.
  • The concept of SLR forces the commercial banks to invest in government securities like government bonds when it wants to dry up liquidity and reduce inflation.

Objectives of Statutory Liquidity Ratio

  • Assures the financial stability of commercial banks so that they can meet all the credit requirements.
  • Changing the SLR rates can encourage or discourage the growth in interest rates on long-term lending programs.
  • By increasing or decreasing the SLR rate, the central bank obliges commercial banks to purchase or invest in government securities when it wants to soak up liquidity from the market.
  • The SLR ratio helps in establishing and controlling all types of bank credit.
  • The central bank uses this tool and modifies the ratio when there is a marked change in inflation levels.
  • When there is a rise in inflation, the bank raises the SLR ratio, which in turn, restricts the bank credit facility. The credit facility is a pre-approved loan facility provided by the bank to the companies wherein they can borrow money as and when required for their short-term or long-term needs.

Final Words

Thus, when there is a recession in the economy, the central bank reduces the SLR ratio, which raises the bank’s credit. This allows commercial banks to have more liquidity. Now, the banks can offer cheaper credit facilities to their customers like lower rates of interest for home loans, etc. The Statutory Liquidity Ratio plays a very prominent role in fixing the base rate of the Indian economy and helps to maintain transparency in the system. It helps to offer low-expenses funds to individuals in the credit market and reduces loan expenses for all borrowers. So, if you are thinking of availing of a home loan and have ready all the documents required for a home loan, then it’s time to do some research. Just like the home loan calculator shows and indicates your eligibility for home loan similarly, the SLR rate also indicates the rise or fall in the loan expenses due to the availability of credit with commercial banks.

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