Besides the CRR all banks are required to invest a portion of their net demand and time deposits in government securities as a part of their statutory liquidity ratio [SLR] requirement [i.e. as excess reserves].
This restricts the bank’s leverage in pumping more money into the economy.
As per the Banking Regulations Act 1949, all Scheduled, Commercial Banks in India must maintain an amount in the form of cash, gold / precious metals, or government approved securities (Bonds) etc, with themselves at any point of time, before providing credit to its customers. The ratio of the liquid assets to time and demand liabilities is termed as Statutory Liquidity Ratio.
How is SLR determined?
SLR is determined as the percentage of total demand and percentage of time liabilities that banks need to have in any or combination of the following forms by the bank itself:
ii) Gold valued at a price not exceeding the current market price,
Specification of cash and gold as permissible forms are primarily on the basis of these being safe and liquid.
iii) Unencumbered approved securities (G Secs or Gilts come under this) valued at a price as specified by the RBI from time to time.
Gold and G Secs (or Gilts) are included along with cash because they are highly liquid and safe assets.
valuation of these securities is specified by the RBI from time to time.
Unencumbered approved securities include
(a) Treasury-Bills of the Government of India.
(b) Dated securities including those issued by the Government of India from time to time under the market borrowings programme and the Market Stabilization Scheme (MSS).
(c) State Development Loans (SDLs) issued by State Governments under their market borrowings programme.
(d) Other instruments as notified by the RBI.
Amount of net demand & time liabilities = 10000 Cr
Rate of SLR(assumed) = 24%
Average cash balance to be maintained = 2400 Cr
The maximum limit of SLR is 40% and minimum limit of SLR is 24%.
The RBI as per need can fix the SLR between these two extremes.
This restriction is imposed by RBI on banks to make funds available to customers on demand as soon as possible.
In a growing economy banks would like to invest in stock market, not in G Secs or Gold as the latter would yield less returns.
One more reason is long term G Secs (or any bond) are sensitive to interest rate changes. But in an emerging economy interest rate change is a common activity.
What is the Need of SLR? The main objectives of maintaining SLR are
SLR acts as a tool for RBI to maintain monetary stability in the country.
With the SLR (Statutory Liquidity Ratio), the RBI can ensure the solvency a commercial bank as this ensures the liquidity and safety of deposits of the bank
Safeguard the customer’s money
SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the volume of bank credit. By changing the SLR the RBI can control the expansion and contraction of bank credit.
By determining the SLR, the RBI, in a way compels the commercial banks to invest in government securities like government bonds.
The SLR requirement facilitates a captive market for government securities which in turn implies negligible refinancing risks in the case of a debt crisis.
The SLR, according to some, is not a monetary tool and is only a prudential requirement to serve as a cushion for safety of bank deposits.
By changing the SLR rates, RBI can
increase or decrease bank credit ie it is a tool for controlling liquidity in the domestic market via manipulating bank credit through a change in SLR..
maintain monetary stability.
RBI can increase SLR to control inflation and
to reduce liquidity in the market
A rise in SLR locks up increasing portion of a bank’s assets, Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and may squeeze out bank credit..
Therefore the cash reserves of commercial banks decrease.
and thus reduces their capacity to grant loans and advances,
This in turn will increase the rate of interest
ie the price of credit rises.
Demand for credit contracts
Therefore when there is inflation in the economy, an increase in the SLR rate by the RBI will reduce availability of credit, leading to a fall in investment and further a decrease in the aggregate demand will ultimately lead to a decrease in prices. Thus it is an anti-inflationary impact.
A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.
RBI can decrease SLR to control deflation and
to increase liquidity in the market
A fall in SLR releases increasing portion of a bank’s assets. Lower liquidity ratio allows commercial banks to maintain a smaller proportion of their resources in liquid form and may increase bank credit..
Therefore the cash reserves of commercial banks increase.
and thus increases their capacity to grant loans and advances,
This in turn will decrease the rate of interest
ie the price of credit falls.
Demand for credit expands
Therefore when there is recession in the economy, a decrease in the SLR rate by the RBI will increase availability of credit, leading to a rise in investment and further a increase in the aggregate demand will ultimately lead to a fall in prices. Thus it is an anti-recessionary impact.
A lower liquidity ratio diverts the bank funds from investment in government and approved securities to loans and advances.
Also through SLR, RBI compels the commercial banks to invest in government securities like government bonds. The SLR requirement facilitates a captive market for government securities which in turn implies negligible refinancing risks in the case of a debt crisis.
If a bank fails to meet its SLR obligation, a penalty in the form of a penal interest payable is imposed.
If a banking company fails to maintain the required amount of SLR, liable to pay to RBI the penal interest for that day @3 %pa above the Bank Rate on the shortfall and
if the default continues on the next succeeding working day, the penal interest may be increased to 5%pa above the Bank Rate for the concerned days of default on the shortfall.