In India, the Reserve Bank of India (RBI) is responsible for managing several key factors of the economy. These factors affect everything from the stability of prices to the efficient regulation of cash flow in the economy. To ensure smooth operation and manage these responsibilities, the RBI has monetary policy tools like the statutory liquidity ratio (SLR) in place. The SLR is among the many monetary components at the RBI’s disposal which help ensure the solvency of banks. It has a direct impact on the economy and in fact, it helps control heavy fluctuation in the economy, which is key to establishing stability.
As a borrower, going beyond knowing the SLR full form to understand the SLR meaning and knowing the impact of changes in the SLR rate is invaluable. This is because the SLR ratio primarily restricts a financial institution’s lending capacity, which in turn affects the interest rates on loans. For this reason, it is smart to know the current SLR rate when you intend to borrow and then evaluate whether it is a favorable decision.
To know more about SLR, how it works and its key components, read on.
The statutory liquidity ratio(SLR) is linked to the mandatory reserve of securities that financial institutions maintain as per the RBI’s instructions. It is a percentage of the institution’s Net Demand and Time Liabilities (NDTL) that must be set aside for investment in liquid assets such as state government or centrally-approved securities. The SLR rate tells institutions how much this ratio must be. It is a percentage issued by the RBI, for which the maximum is 40%.
Currently, the SLR rate in 2020 is 18%. For deposit-taking NBFCs, the SLR rate is 15%.
The SLR rate has an important role to play in controlling how much money financial institutions can inject into the economy. An increase in the SLR rate restricts this ability, while a decrease in the SLR rate offers greater freedom. As such, paying attention to any changes made to the SLR rate can provide financial insights, especially in terms of you borrowing cost-effectively.
There are 2 main components that comprise the SLR, and as per Section 56 and Section 24(2A) of the Banking Act, 1949, all local area banks, UCBs, scheduled commercial banks, and state and central co-operative banks must maintain the SLR as per the rate. The 2 components are as follows.
The SLR regulates credit growth and inflation in the Indian economy. If SLR increases, institutions can lend less, hence there is less liquidity in the economy and there is less upward pressure on inflation. The SLR also dictates the amount of liquid assets financial institutions must have on hand to meet the need of depositors, should it arise. SLR works as a monetary tool that promotes investment in government debt instruments and securities from financial institutions. As such, funding is parked in the most secure assets as the approved securities are free of risk.
Additionally, SLR also affects other parts of the economy. In some cases, you stand to gain for these changes. A good example is that SLR is one of the reference rates used to determine the base rate for loans. When the SLR decreases, lenders are likely to offer lower interest rates but if the SLR increases, it is likely that the interest rate will rise as well.
The primary objective of the SLR rate is to maintain liquidity in financial institutions operating in the country. Besides this, the SLR rate also helps:
Simply put, SLR is the ratio of liquid assets that a financial institution must keep to its NDTL. To calculate SLR, this is the formula to use:
SLR = (Liquid Assets / (Time + Demand Liabilities)) * 100
There are several liquid assets institutions can consider to meet their statutory reserve requirements. They are as follows:
The RBI levies a 3% annual penalty over the bank rate if commercial banks do not maintain liquid assets as per the SLR. Failure to pay this penalty will result in a 5% fine the following day. The objective of imposing such a penalty is to ensure that customers have access to liquidity whenever the need arises.
There are many differences between SLR and CRR and they are as follows.
|Reserves are in the form of liquid assets||Reserves must be in the form of cash|
|SLR controls credit expansion||CRR controls liquidity|
|Institutions earn interest on assets parked with approved securities||Institutions don’t earn any returns on cash parked as CRR|
|Liquid assets are maintained by the financial intuitions||Cash reserves are maintained by the RBI|
Having a clear understanding of the SLR gives you deeper insight into the core aspects of the Indian economy. Armed with such information, you are now primed with the tools to take cost-effective, optimal, and favorable financial decisions confidently.