Statutory Liquidity Ratio (SLR) is one of the key instruments used by the Reserve Bank of India (RBI) to safeguard the money deposited with banks while also controlling the supply of money in the economy. In the following sections we will discuss the aspects of RBI SLR, how it safeguards the deposits kept with banks and how changes in SLR affect the flow of credit in Indian markets.
What is Statutory Liquidity Ratio (SLR)?
SLR refers to the proportion of Net Demand and Time Liabilities (NDTL) that commercial banks are required to mandatorily maintain in the form of liquid assets. Statutory Liquidity Ratio has to be maintained by banks in addition to Cash Reserve Ratio (CRR) that financial institutions need to maintain with the RBI. In other words, it refers to the proportion of deposits that banks have to maintain in the form of cash or other liquid assets to ensure solvency of the bank. Bank solvency refers to a bank’s ability to cover its various liabilities.
What is the meaning of Net Demand and Time Liabilities (NDTL)?
Let us assume that you have deposited a certain amount of money in a savings account with ABC Bank. Though the money you have deposited with the bank is an asset for you, it is a liability (debt) for the bank as you can demand the money back at a later date. The most common example of a time liability for a bank are the fixed deposits that its customers hold with the bank that are scheduled for maturity after a specific period of time.
On the other hand, the amount of money that the ABC Bank has deposited with other banks including the RBI acts is an asset for ABC Bank. Additional assets for the bank may include money lent out in the form of loans as well as cash, treasury bonds, certificates of deposits, etc. assets held by the bank.
The difference between all the liabilities and assets held by a bank is known as the “Net Demand and Time Liabilities (NDTL)”.
For example, let’s assume the total demand and time liabilities of a bank amount to Rs. 10,000 while its deposits with other banks amount to Rs. 5,000. Thus, the bank’s NDTL will be Rs. 10,000 – Rs. 5000 = Rs. 5,000.
NDTL = (Demand and Time Liabilities of the bank – Assets held with other banks)
Let us understand the meaning of “Demand liabilities” and “Time liabilities”. Demand liabilities refer to all the liabilities that the bank has to pay on demand. For example current account deposits, savings account deposits and demand drafts. While Time liabilities refer to the liabilities that the bank has to pay after an pre-determined period of time. This would include fixed deposits, recurring deposits, etc.
Note: Demand and time liabilities include deposits made by both the bank’s customers and other banks.
Statutory Liquidity Ratio (SLR) – Current Rate and limit
The current SLR as per RBI’s Major Monetary Policy document dated 4th Oct’19 is 18.75% of NDTL, however banks can maintain it at a higher level if they so choose.
For example if NDTL of a bank amounts to Rs. 10,000, then the bank has to maintain liquid assets worth Rs. 1,875 as SLR.
It should be noted that under existing regulations of RBI, the maximum SLR maintained by a bank cannot exceed 40% of NDTL. The following are the historical RBI SLR Rates in India:
|Date||SLR Rate (%)|
|12 October 2019 (current)||18.50|
|6 July 2019||18.75|
|13 April 2019||19.00|
|5 January 2019||19.25|
|14 October 2017||19.50|
|24 June 2017||20.00|
|7 January 2017||20.50|
|1 October 2016||20.75|
|9 July 2016||21.00|
|2 April 2016||21.25|
|7 February 2015||21.50|
|9 August 2015||22.00|
|14 June 2015||22.50|
Source: RBI Website
Components of SLR
RBI mandate specifies that Statutory Liquidity Ratio (SLR) must be maintained in the form of liquid assets. An asset is considered as liquid when it can be easily converted to cash.
Key features of such assets include easily transferable from one owner to another. The following liquid assets can contribute to the SLR of a commercial bank:
- Treasury bills,
- Government bonds,
- Government approved securities,
- Securities issued under Market Stabilization Scheme,
- Securities issued under Market Borrowing Programmes and
- Cash reserves
Purpose of Statutory Liquidity Ratio
- To Control the Flow of Bank Credit: SLR impacts the availability of credit with the bank that can be forwarded as loans. Thus increasing or decreasing SLR can help RBI control the flow of money in the economy.
- To Ensure Solvency of the Bank: SLR ensures that the bank has enough liquid assets to meet its financial liabilities in the form of demand or time liabilities at any given time.
Impact of Change in SLR
- When RBI increases SLR,banks are required to maintain a larger amount in the form of liquid assets held by them. Thus, the amount of money available with banks to lend out in the form of loans decreases. As a result, liquidity in the economy decreases which may help control inflation. However, this lower money supply often results in lower consumption which may result in a slowdown of economic growth.
- When RBI decreases SLR, banks have less money tied up in liquid assets held by them. Thus they have more money to lend leading to increased liquidity in markets. While such a situation can help promote economic growth through increased consumption, it may also result in significantly higher inflation.
What is the need for SLR when banks already maintain CRR with RBI?
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are two of the key tools used by RBI to safeguard the money of depositors. While CRR refers to the amount of cash that banks have to deposit with RBI, SLR refers to the amount of liquid assets that the banks have to maintain internally in the form of liquid assets.
On the face of it, both seem to have a similar impact in case of either upward or downward movement. This leads to the obvious question – why is SLR needed when the banks already maintain CRR? The answer lies in the role that each plays. Let’s illustrate these unique roles with an example:
The current CRR is 4%, i.e., if you deposit Rs. 100 with a bank, then the bank has to deposit Rs. 4 with RBI, with the rest being used to further the bank’s profits. However, the nominal amount of Rs. 4 is not enough to safeguard your deposit of Rs. 100.
Additionally, the banks do not earn any interest on CRR. As a result, if CRR is increased to a higher value, banks will have lesser money to lend. Hence, bank loans will become more expensive and the interest rates on deposits will also decrease so that banks that maintain a higher margin. The money that is maintained as CRR with RBI ensures that the central bank has enough funds on hand to act as a lender of last resort in case of emergencies.
Therefore, RBI applies SLR, which requires banks to mandatorily maintain liquid assets with themselves at pre-determined levels to ensure they have enough money to cover their liabilities in an emergency. What’s more, banks can also earn interest/returns on these liquid assets held to maintain SLR. Thus, implementation of SLR by RBI provides the twin benefit of safeguarding depositor’s interests while simultaneously ensuring that the bottom line of banks is not adversely affected.
This is the key reason why SLR is used in conjunction with CRR by RBI instead of being used separately.
What if banks do not maintain SLR?
It is mandatory for banks to maintain RBI SLR. However if a bank fails to maintain SLR at the required level, they have to pay a penal interest for that day at the rate of 3% per annum above the bank rate on the shortfall. If they fail to maintain SLR on the next day as well, they have to pay penal interest at the rate of 5% per annum above the bank rate on the shortfall.
Currently (as of November 2019), the RBI bank rate is 5.40% so in case of non-maintenance of SLR, the bank will have to pay penal interest at the rate of 8.40% p.a. One the second day, this penal interest rate will be charged at 10.40% p.a.