Statutory Liquidity Ratio, in short, SLR is an indispensable tool in the monetary policy armory of central banks among others, especially in countries such as India, wherein it plays a very significant role concerning regulations within the banking sector.
SLR is the minimum percent of the commercial bank’s NDTL that it has to keep in liquid assets such as cash, gold, and government-approved securities. During this process, SLR regulates inflation by keeping a portion of funds in liquid form. This helps balance the financial stability of the economy to track credit growth according to inflation.
In this blog, we will look closer at the Statutory Liquidity Ratio: what it is, how to calculate it, and how it differs from other types of liquidity measures, such as the Cash Reserve Ratio.
Additionally, we will also discuss why SLR is so important for the soundness of the whole banking system and the economy at large.
What is the Statutory Liquidity Ratio?
The abbreviated form SLR stands for that fraction of a bank’s NDTL that the banking concern is, under statutory compulsion, required to maintain in the form of liquid assets.
Liquid assets may take the shape of cash and gold and government-approved securities like treasury bills and government bonds. Within this context, the SLR requirement is fixed by the central bank-Reserve Bank of India is perceived to be a tool for monetary policy to monitor the flow of credit within the banking system.
Thus, for the financial institutions to adequately undertake their obligations, more so at the time of financial distress or during the economic slowdown, the central bank at the top forces the banks to hold liquid assets of a certain percentage.
How is SLR Calculated?
It will be rather interesting to understand how banks maintain their statutory liquidity ratio. To understand this, one must be aware of the statutory liquidity ratio formula.
- Liquid Assets: Different elements that make this up are cash, gold, and securities that can readily be converted to cash.
- NDTL: This is short for net demand and time liabilities. Demand liabilities include savings accounts, current accounts, etc., and time liabilities include fixed deposits, etc.
Banks are obliged to maintain the exact proportion of NDTL liquidity supplied by the central bank. Suppose the total liabilities are ₹ 100 crores and the existing SLR is 20%, then ₹ 20 crores of liquid assets are held by the bank.
Current SLR Ratio
It can alter the existing SLR ratio based on the economic condition and the policy aim of the central bank. The changes in SLR are employed as a tool for controlling liquidity by the central banks to check inflation or stimulate credit growth.
For instance, the Reserve Bank of India always revises and alters the SLR from time to time with the intention of maintaining stability in the financial system.
As of 2024, SLR in India was about 18% but it usually used to fluctuate.
Hence any financial institution or any business needs to be updated about the latest figures that are issued from time to time by the central bank.
Difference between SLR and CRR
There are two types of statutory tools that a regulatory body of any country utilizes, namely Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio. Both have different meanings and requirements.
SLR: It is the portion of a bank’s net demand and time liabilities (NDTL) that needs to be kept in liquid assets like gold, cash, or securities that have been approved by the government.
CRR: It is the portion of a bank’s total deposits that must be kept as reserves with the central bank in cash form. This amount cannot be used for lending or investment.
The basic fundamental difference between SLR and CRR is the nature of the reserves. Whereas SLR requires liquid assets to be held by the banks that they can use during a financial problem, CRR implies cash holdings with the central bank that diminish the quantum of money available to the banks for disbursal.
The other underlying difference can be perceived as: CRR is kept with the central bank and therefore it presents no returns to the banks. However, there may be a scope of returns on the assets that are kept under SLR and these can be in the form of government securities. Hence, from the perspective of the bank, SLR tends to be very productive.
Importance of SLR
The Statutory Liquidity Ratio has played a very important role in the maintenance of stability in the banking system. Following are the key reasons why the SLR is crucial not only to the banks but also for the whole economy:
- Provides Liquidity: A central bank ensures that financial institutions, especially banks, can meet their current liabilities by infusing a pre-determined amount of liquidity into the banks. This avoids an illiquidity problem, especially during periods of financial turmoil or economic uncertainty.
- Checks Inflation: The central bank may employ the SLR to decide on the cash amount a bank is to hold for lending. A rise in SLR decreases the availability of funds to be lent out, deflating thereby inflation. Deflation or recession, when needed to stimulate the growth of the economy, may be achieved by reducing SLR, which raises the lending capacity.
- Maintains financial stability: A higher percentage of SLR would automatically mean that a greater amount of their receipt is kept in liquid form and hence gives strength to the banking system at the time of financial crisis.
- Encourages Investment in Government Securities: SLR, indirectly or otherwise, encourages govt. borrowing programs by insisting that banks hold govt.-approved securities in liquid form. This ensures general market demand for government securities. It ultimately helps finance public projects and development initiatives.
- Prevention from Unduly High Lending: SLR restricts credit expansion unduly high. The central bank controls the amount that the banks can lend by the specification of a rate and hence prevents overexpansion of credit beyond the sustainable levels, with the objective of not triggering either asset bubbles or an overheated economy.
Who Decides the SLR?
It is fixed in most countries by the central bank. In India, for instance, this ratio is fixed and reviewed by the Reserve Bank of India about the prevailing state of the economy and the objectives of its policy. Generally, the SLR is used by central banks to achieve a trade-off between growth and inflation to ensure liquidity and resiliency in the banking system.
This also forms a part of the broad monetary policy toolkit that central banks use along with among other tools, the CRR, repo rates, and reverse repo rates to keep the money supply in check with inflationary pressures.
How Does SLR Affect Banks and the Economy?
- Impact on Banks: The SLR directly impacts the lending ability of the banks. The higher the SLR, the greater would be the compulsion to transform a larger fraction of deposits into liquid cash; this increases the cost of reducing their lending ability. The credit availability decreases, hence most likely denting the profitability of banks. A lower SLR, on the contrary, liberates the amount of funds, hence allowing them to flow into loans, thereby increasing the loan growth and resultant income for banks.
- Economic Impact: A change in SLR significantly affects the economy. A higher SLR tightens the banking system’s liquidity and objectively makes credit dearer, thus hurting businesses and consumers who borrow money from banks. This may slow down economic growth but helps control inflation. Reducing the SLR may trigger economic activities since more funds are made available to give as loans; it might give rise to inflationary pressures if badly managed.
- Promotes Government Bond Purchases: One implication of the SLR requirement is that banks are encouraged to invest in government securities since these form part of the approved liquid assets toward meeting SLR requirements. Banks often buy treasury bills and bonds, thus making provisions for government needs with stable means of finance.
The Future of SLR within a Dynamic Economy
The economy would then keep moving ahead and the Statutory Liquidity Ratio would be an important constituent of the economic landscape, whereby SLR could definitely be adjusted with respect to any overarching international economic trends, any inflationary pressures, or changes in domestic financial stability by the central bank.
During the last ten years, digital banking, among other Fintech innovations, has completely altered the face of banking. These drivers have made the regulators think afresh about conventional tools like SLR. With the increasing integration and complexity of the financial markets, a suitable adaptation of SLR in response to emerging needs of the economy will always have to be factor-balanced between stability and liquidity.
Conclusion
The Statutory Liquidity Ratio equally provides a very important and critical statutory requirement, ensuring that banks at all times have adequate liquidity in their books to meet their obligations.
SLR insists on holding a certain percentage of NDTL in cash gold or government securities to control credit growth maintain liquidity and ensure financial stability within the banking system. This is important because it is considered a kind of signal for banks to reach their optimal level of liquidity position and, at the same time, to meet the requirements of the central banks.
From a wider perspective, the ratio rescues the whole economy from inflationary tendencies and financial instability, hence ensuring soundness in the financial system. The SLR is supposed to be set appropriately to manage the economy by stabilizing banks and engendering sustainable growth.
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