SLR is a crucial rule set by the Reserve Bank of India (RBI). 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. This rule ensures that banks always have enough money to meet their obligations and handle unexpected situations.
The SLR rate is the percentage set by the RBI, telling banks how much of their total deposits they must keep as this reserve. The RBI uses this rate to control how much money is available for lending, affecting interest rates and the overall economy.
Keep reading to explore SLR in detail, its importance for banks and the economy, and how changes in the SLR rate can impact lending practices, interest rates, and the stability of the financial system.
What is SLR rate?
SLR stands for statutory liquidity ratio is the percentage of minimum amount of money a bank needs to keep in safe and easily accessible forms, like cash, government securities, or gold.
The statutory liquidity ratio (SLR) is linked to the mandatory reserve of securities that financial institutions maintain as per the RBI’s instructions. 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%.
What is the current SLR rate?
Currently, the SLR rate is 18%. 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.
What are the Components of the Statutory Liquidity Ratio?
There are 2 main components that comprise the SLR. 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:
- Liquid Assets: Liquid Assets are the assets with financial institutions that can be easily liquidated, such as gold, cash, and government bonds. In some cases, they can also consist of eligible securities that are availed through specific, RBI-approved securities. There are several approved securities that fall under this category.
- Net Demand & Time Liabilities: This is the aggregate of fixed deposit, current account and savings account balances held by a financial institution. More generally, NDTL or Net Demand & Time Liabilities is the sum of the demand liabilities, time liabilities, and other liabilities, minus the deposits held in other banks. Based on the total amount, the institution must maintain the current SLR as liquid securities.
How is the SLR calculated?
Simply put, liquid assets that a financial institution must keep to its NDTL, demand and time liabilities into the SLR ratio formula. To calculate SLR, this is the formula to use:
Formula to calculate SLR is,
SLR = (liquid assets / (demand + time liabilities)) * 100%.
Let’s examine ABC Bank as an example. The bank possesses Rs. 1,65,39,40,000 in liquid assets. The bank has Rs. 20,000,000,000 in NTDLs (net time and demand liabilities). Help ABC Bank’s management in calculating the statutory liquidity ratio.
Statutory liquidity Ratio = LA(Liquid Assets) / NTDL(Net Time and Demand Liabilities)
= (Rs. 1,65,39,40,000 / Rs. 20,000,000,000)*100
As a result, the bank’ SLR is 8.27%.
How is the statutory liquidity ratio calculated?
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
Why does the cash reserve ratio keep on changing?
CRR serves as a safety net for customers, ensuring that banks have enough liquidity to handle a surge in demand for funds through withdrawals. Beyond that, the RBI is free to meet its other objectives and slash or increase the CRR, meaning that it can, from time to time, regulate the CRR required from banks to better control the flow of money in the economy. Since this objective is one that is subject to the dynamics of the economy, and therefore, to change, the cash reserve ratio is bound to go up or down periodically.
Why does the statutory liquidity ratio keep on changing?
The Statutory Liquidity Ratio (SLR) is a regulatory requirement imposed by the central bank on commercial banks and financial institutions. It mandates that a certain percentage of their Net Demand and Time Liabilities (NDTL) should be kept in the form of highly liquid assets, such as government securities, cash, or gold. The primary reasons for the SLR changing over time include:
- Economic and monetary policy objectives: Central banks use SLR as a tool to achieve specific monetary policy objectives. When they want to control inflation or stimulate economic growth, they may increase or decrease the SLR requirement accordingly.
- Liquidity management: SLR helps ensure that banks maintain a certain level of liquidity to meet their depositors' demands and manage short-term liquidity crises. During periods of economic uncertainty or financial instability, central banks may raise SLR to enhance financial stability.
- Banking sector health: SLR requirements can change based on the perceived health of the banking sector. If there are concerns about the stability of banks or their ability to meet their obligations, the central bank may adjust the SLR to mitigate these risks.
- Government borrowing: Changes in government borrowing patterns can impact SLR. If the government issues more bonds or securities, banks may need to purchase them to comply with SLR, increasing the SLR requirement.
- International factors: Global economic conditions and international financial markets can also influence SLR. Changes in global interest rates, exchange rates, or capital flows can impact the liquidity and stability of banks, leading to adjustments in SLR.
- Financial sector reforms: Regulatory changes or reforms in the financial sector can lead to adjustments in SLR. These reforms may be aimed at enhancing financial stability, improving risk management practices, or aligning with international standards.
- Economic conditions: The overall economic conditions of a country, including factors like inflation, GDP growth, and financial stability, can influence SLR. In times of economic stress or inflationary pressures, central banks may adjust SLR to manage these challenges.
- Policy goals: Central banks often use SLR to achieve specific policy goals, such as promoting lending to priority sectors or encouraging banks to invest in certain types of assets. Changes in policy goals can result in changes in SLR.
It is important to note that SLR is not a fixed ratio and can be adjusted by the central bank as needed to achieve its objectives and respond to changing economic and financial conditions. Banks must regularly monitor and manage their SLR compliance to ensure they meet regulatory requirements.
Difference between CRR and SLR
CRR and SLR are both components of the RBI’s monetary policy and while the CRR stands for Cash Reserve Ratio, SLR stands for Statutory Liquid Ratio. SLR is the percentage of deposits a bank needs to keep as liquid assets, while CRR is the ratio of cash reserves banks need to keep with RBI.
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
CRR and SLR rate - Feb 2024
•CRR = 4.50%
•SLR = 18%
Now that you know what is CRR and have some insight into how it impacts lending, investments, and the economy at large, proceed to make informed financial decisions.
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.
Objectives of Statutory Liquidity Ratio
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:
- Control credit flow and inflation
- Promote investment in government securities
- Ensure solvency in financial institutions
- Prevent asset liquidation when the CRR is raised
- Aid the government’s debt management program
- Fuel demand and growth, for instance, when the SLR decreases and liquidity increases
Assets Specified for SLR by RBI
There are several liquid assets institutions can consider to meet their statutory reserve requirements. They are as follows:
- Treasury bills
- Government bonds
- Dated GOI securities
- State development loans
- Dated GOI securities issued under the market borrowing scheme or market stabilisation scheme
- Other approved securities
Impact of SLR on the home loan borrower
The Statutory Liquidity Ratio (SLR) is a requirement set by central banks that mandates financial institutions to maintain a certain percentage of their deposits in specified liquid assets like government securities. While SLR primarily impacts banks and their liquidity management, it indirectly influences home loan borrowers in the following ways:
1. Interest rates:
- SLR can influence the overall interest rate scenario in the economy. When central banks adjust SLR requirements, it may impact the cost of funds for banks. If SLR is reduced, banks might have more funds available for lending, potentially leading to lower interest rates on loans, including home loans.
2. Availability of funds:
- Changes in SLR requirements can affect the availability of funds for banks. If SLR is increased, banks may need to set aside more funds in liquid assets, potentially reducing the funds available for lending. Conversely, a decrease in SLR could free up more funds for lending.
3. Loan approval and terms:
- Banks use various factors, including liquidity conditions, to assess their lending capacity. Changes in SLR might influence a bank's willingness to approve new home loans or alter the terms and conditions, such as loan-to-value ratios and interest rates.
4. Economic conditions:
- SLR adjustments are often made by central banks in response to broader economic conditions. If SLR is increased to manage inflation or economic stability, it might have an indirect impact on interest rates and the overall economic environment, affecting borrowers, including those with home loans.
5. Market sentiment:
- Changes in SLR can signal the central bank's stance on monetary policy and impact market sentiment. This, in turn, can influence investor behaviour, interest rates, and overall economic conditions, which may have repercussions for home loan borrowers.
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 number 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 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.
The RBI's Statutory Liquidity Ratio (SLR) requires banks to set aside a portion of deposits in liquid assets, indirectly affecting home loans. Key points:
- Interest rates: SLR changes can impact home loan rates, potentially causing increases.
- Banking system liquidity: SLR influences funds for lending, affecting liquidity in the home loan market.
- Floating interest rate home loans: SLR changes may adjust monthly instalments for floating interest rate home loans.
In India, the Statutory Liquidity Ratio (SLR) is maintained by individual banks. Each bank is responsible for maintaining a certain percentage of their Net Demand and Time Liabilities (NDTL) in the form of specified liquid assets like cash, gold, government securities, etc., as mandated by the Reserve Bank of India (RBI). The RBI sets the SLR requirement as part of its monetary policy framework to ensure liquidity and stability in the banking system. Banks are required to regularly report their SLR compliance to the RBI.
The Statutory Liquidity Ratio (SLR) is important for the following reasons:
- Liquidity Management: SLR helps banks manage liquidity by requiring them to maintain a certain percentage of their NDTL (Net Demand and Time Liabilities) in liquid assets. This ensures that banks have enough funds available to meet customer demands and payment obligations.
- Financial Stability: SLR contributes to the stability of the banking system by ensuring that banks hold a portion of their liabilities in safe and easily convertible assets. This protects them during times of financial stress or liquidity shortages.
- Credit Control: SLR is a monetary policy tool used by the central bank to influence credit creation. Adjusting the SLR requirement allows the central bank to regulate the flow of credit and liquidity in the banking system. Increasing SLR limits banks' lending capacity, while decreasing it encourages lending and stimulates economic growth.
- Government Securities Market: SLR promotes the development of the government securities market. Banks are mandated to invest a significant portion of their SLR holdings in government securities, which supports government borrowing and enhances the bond market.
- Risk Mitigation: SLR helps banks mitigate risks. Holding a portion of their assets in liquid instruments reduces their exposure to credit and liquidity risks. This ensures that banks have readily sellable or pledgeable assets to fulfill their obligations during uncertain times.
In summary, SLR is vital for maintaining financial stability, regulating credit growth, and ensuring the liquidity and solvency of banks. It plays a crucial role in supporting the functioning of the financial system and contributing to overall economic stability.
The Reserve Bank of India (RBI) increases the Statutory Liquidity Ratio (SLR) to regulate the monetary policies in the country. The SLR is the percentage of deposits that banks have to maintain in the form of liquid assets, including cash, gold or approved securities, with the RBI. Here are some reasons why the RBI may increase the SLR:
- Tightening Monetary Policy: The RBI may increase the SLR as a part of its monetary policy to tighten the money supply in the economy. This helps in controlling inflation as reducing the liquidity in the system reduces the amount of money available for lending.
- Consumer Credit Demand: An increase in consumer credit demand may lead to an increase in SLR to control credit expansion, keeping a check on the loan defaults.
- Foreign Exchange Reserve Management: Countries with a current account deficit may increase the SLR to manage their foreign exchange reserves, and to reduce the country's dependence on external borrowing.
- Economic Instability: Increasing the SLR may help stabilize the banking system and improve the liquidity position of banks during economic turbulence.
- SLR-to-Deposit Ratio: The RBI may increase the SLR to maintain the SLR-to-deposit ratio set under the Banking Regulation Act, 1949.
The Statutory Liquidity Ratio (SLR) is calculated using the following formula:
SLR = (Total Liquid Assets / Net Demand and Time Liabilities) * 100
Here, "Total Liquid Assets" refers to the liquid assets held by banks, such as cash, gold, government securities, and other approved securities. These assets are readily convertible into cash without significant loss in value.
"Net Demand and Time Liabilities" (NDTL) represents the total deposits of a bank, including demand deposits (current and savings accounts) and time deposits (fixed deposits) of customers, minus the deposits held by other banks. NDTL represents the liabilities of the bank towards its customers.
The SLR is expressed as a percentage, indicating the proportion of a bank's NDTL that must be maintained in the form of liquid assets. The percentage is determined by the central bank or regulatory authority of the country and may vary over time based on monetary policy objectives and economic conditions.
It's important to note that the specific components and calculation methodology of SLR may vary across different countries and regulatory frameworks. The formula provided here represents a general formula commonly used for SLR calculation.
In India, the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) rates are set by the Reserve Bank of India (RBI). The RBI is the central banking institution in India and has the authority to regulate monetary policy and banking operations in the country.
The RBI determines the CRR and SLR rates based on various factors such as economic conditions, inflationary pressures, liquidity requirements in the banking system, credit growth, and financial stability considerations. These rates are used as monetary policy tools to manage liquidity, credit creation, and overall financial stability in the economy.
The RBI periodically reviews and adjusts the CRR and SLR rates to align with its monetary policy objectives and to address changing economic conditions. The rates set by the RBI have a direct impact on the liquidity position of banks and the availability of credit in the economy.