A Complete Guide to Statutory Liquidity Ratio (SLR)

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5 min 22 Feb 2023

Complete Guide to Statutory Liquidity Ratio

Highlights:

What is Statutory Liquidity Ratio or SLR rate?
Why Do We Need SLR?
Here's What the Statutory Liquidity Ratio Helps the RBI Do
Here's How SLR Works and Why It Is Important

The central bank of every country is responsible for regulating the flow of credit within the economy as well as the interest rate at which the credit flows. In India, the Reserve Bank of India is responsible for this task and it does so with the help of an instrument called the Statutory Liquidity Ratio. 

What is Statutory Liquidity Ratio or SLR rate? 

The Statutory Liquidity Ratio refers to the percentage of deposits a bank or commercial lender must hold with itself in the form of cash, Gold or other securities before it can lend money to borrowers. 

The Reserve Bank of India does not have any say with regards to the kind of deposit that a bank or lender must maintain. However, the Reserve Bank of India is responsible for deciding the statutory Liquidity ratio, which stands at 18% currently. 

In case a bank fails to maintain this ratio, it must pay a penalty to the central bank. If the bank fails to maintain the defined Statutory Liquidity Ratio for a day, it must pay a penalty to the RBI at a rate 3% above the base rate on the deficit amount. However, if the bank defaults for an extended period, they must pay a penalty at an interest rate 5% above the base rate on the deficit amount.

Now that we know what statutory liquidity ratio is, let us look at why the SLR rate is important and what objectives does the central bank aim to achieve with the help of 

Why do we Need SLR?

Essentially, the Reserve Bank of India uses the concept of SLR to ensure smooth growth of the economy. When the growth within the economy slows down, the central bank reduces the SLR, which leads to banks and commercial lenders having more money and therefore, they lend out money at lower interest rates. This increases the flow of money within the economy, reduces inflationary pressures and promotes economic growth. On the other hand, when the RBI increases the SLR, banks have less money to give, which leads to increased interest rates and therefore, reduced flow of money within the economy. The RBI increases SLR when it must bring inflation under control.

 Let us look at the other ways in which the SLR helps RBI maintain economic growth.

Here's What the Statutory Liquidity Ratio Helps the RBI do

With the help of SLR, the RBI helps commercial banks stay stable and ensures all financial institutions within the country are solvent. The RBI uses SLR to keep prices under control. This helps the economic stay on track in terms of economic growth. SLR allows RBI to ensure that all banks and commercial lenders within the country have a stake in government securities.

The next question that now arises is: how does SLR work? Read on to know the answer. 

Here's How SLR Works and Why it is Important 

As per the rules laid down by the Reserve Bank of India, all banks operating in India must maintain a part of their Net Demand and Time Liabilities in the form of cash, gold and other liquid assets. SLR or Statutory Liquid Ratio is the ratio of cash, gold and liquid assets to that of the Net Demand and Time Liabilities.

As of now, the SLR stands at 18% but the central bank of the country has the liberty to raise the SLR to up to 40%. All banks operational in India must send a detailed report to the RBI every alternate Friday regarding the SLR they have been maintaining. In case their SLR is below the percentage fixed by the RBI, they must pay a penalty to the central bank of the country for the days they have defaulted. 

All banks have what is known as the risk capital. Risk capital refers to the money that the owners of the company will provide the bank in case of any problems. 

Earlier, banks used to dip into their risk capital when they wanted to take risk. This sometimes led to banks facing liquidity issues. Therefore, the Reserve Bank of India came up with the concept of SLR. Today, SLR ensures that the risk capital of a bank is entirely secure. It does so by making sure that a bank's SLR is equivalent to its capital risk.

If you wish to calculate the Statutory Liquidity ratio, use the following formula: 

SLR = (liquid assets/demand time liabilities)*100% 

Final Words 

One of the key responsibilities of the central government of any company is ensuring that all financial institutions within the country stay stable and solvent and the economic growth of the country progresses smoothly. SLR, along with other cash reserve ratio and base rate, are important tools in the armour of the RBI which helps it achieve its objectives.

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