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The RBI Act requires all commercial banks (and some other designated institutions) in the nation to maintain a specific percentage of their demand and time deposits (NDTL or net demand and time liabilities) in their vault as liquid assets. This is referred to as the statutory liquidity ratio. The term statutory here refers to a legal obligation, while the term liquid asset refers to assets such as cash, gold, and authorised securities (government securities). The RBI publishes frequent updates on which assets are considered liquid under SLR. Similarly, it establishes institution-specific criteria for the retention of SLR.
Which institutions are obligated to maintain SLR?
The SLR is a critical regulatory requirement for Scheduled Commercial Banks (SCBs), as they are the financial system’s leading actors. However, several other institutions are mandated to maintain the SLR. The following institutions are obliged to maintain SLR:
All commercial banks (scheduled and non-scheduled), primary (urban) cooperative banks (UCBs), and state and central cooperative banks. SLR is calculated as a percentage of a bank’s Net Demand and Time Liabilities (NDTL). SLR is calculated as a percentage of deposits.
What is the rationale behind SLR?
SLR is a monetary policy tool in theory (a direct instrument). However, SLR has aided the government in the sale of its assets or debt instruments to banks. The SLR was 38.5 percent during the pre-reform period. Banks are required to invest 38.5 percent of their deposits in government securities in this country.
There are a few reasons why the SLR is critical for the government’s debt management approach to succeed, despite the fact that the SLR is a monetary policy tool on the RBI’s table.
The majority of banks will retain their SLR in the form of government securities to generate interest. In India, the average interest rate (yield) on a ten-year bond is now approximately 8.5 percent.
Since the SLR is a statutory obligation and banks prefer to hold their SLR in the form of income-producing assets, the government may simply sell its bonds to banks. This indicates that SLR aided the government’s debt management effort. Securities with a value more than the SLR limit will be eligible for accommodation (temporary loan) under the RBI’s repo programme. Naturally, all banks will hold government assets over the SLR limit to obtain rapid liquidity from the RBI by submitting them to the Repo. Typically, commercial banks in India keep between 25% and 30% of their NDTL in government securities.
The current trend of SLR reform is to progressively decrease it to allow banks to lend more to the private sector.
SLR-eligible assets
SLR-eligible assets include cash, gold, and RBI-approved securities. The majority of banks maintain the SLR in the form of recognised assets — central government bonds and treasury bills – since they provide a decent rate of return.
According to the RBI’s announcement, the SLR should be in the following forms: a) cash, b) gold valued at not more than the current market price, or c) unencumbered investment in any of the following instruments, namely:
(1) Government of India dated securities or
(2) Government of India Treasury Bills; or
(3) State Government Loans for Development (SDLs)
(d) The deposit and unencumbered authorised securities that a banking firm formed outside India is obliged to make with the Reserve Bank;
(e) Any surplus amount held by a scheduled bank with the Reserve Bank beyond the minimum balance required under section 42 of the Reserve Bank of India Act.
SLR’s Importance
The SLR is used by the government to keep inflation and liquidity under control. Increases in the SLR will help to keep inflation under control, while decreases will help to stimulate economic growth in the economy. Although the SLR is a monetary policy instrument of the Reserve Bank of India, the government must ensure the success of its debt management programme. SLR has aided the government in its efforts to sell its securities or debt instruments to financial institutions. The vast majority of banks will preserve their SLR in the form of government securities since doing so will provide interest revenue for them.
Conclusion
When it comes to controlling the liquidity of the economy, the SLR is a blunt tool that is not updated regularly. When the economy is experiencing a slowdown in borrowing, it is a safe alternative for banks to invest in and receive interest on.
