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's full form to understand its meaning and knowing the impact of the SLR rate change 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.
What is SLR rate?
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%.
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, 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
- Liquid Assets: These are assets financial institutions have 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 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.
A simple formula for CRR would be:
CRR = (Liquid cash/ NDTL) *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.
Difference between CRR and SLR
CRR and SLR are both components of the RBI’s monetary policy and while the CRR full form is Cash Reserve Ratio, SLR stands for Statutory Liquid Ratio. SLR describes the percentage of deposits a bank needs to keep as liquid assets, however, here, these funds are maintained not just in the form of cash, but gold, PSU bonds, government securities, and any asset specified by the RBI.
CRR and SLR rate 2021:
The current rates as of August 2021 are:
- CRR = 4%
- SLR = 18%
The key differences between CRR and SLR can be summarised as:
- CRR includes cash reserves only, but SLR includes liquid assets such as gold, bonds, and securities as well
- No interest is earned on the funds reserved as CRR, but banks earn on SLR
- CRR funds are kept with the RBI, but SLR funds are kept with the bank itself
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.
How does SLR work?
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.
What are the objectives of the SLR rate?
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
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
What are the specified assets for SLR?
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
What are the penalties if SLR is not maintained?
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.
What is the difference between SLR & CRR?
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.