Definition
The Statutory Liquidity Ratio (SLR) is a term used in banking regulation, primarily in India. It is the proportion of a bank’s total deposit that it is obliged to maintain as liquid assets, such as government bonds and gold. The aim is to ensure that the bank has enough funds available to meet any immediate demands from depositors.
Key Takeaways
- Statutory Liquidity Ratio (SLR) is a term used in banking, referring to the minimum percentage of deposits that a bank is required to maintain in the form of cash, gold reserves, government approved securities before providing credit to its customers.
- SLR is designed to restrict the bank from liquidating assets whenever it faces a financial crunch and to ensure banks maintain a minimum level of solvency. It’s used to control the bank’s leverage for credit expansion.
- The rate of SLR is determined and maintained by the central banks of each country (like the Reserve Bank of India in India’s case) and can be used as a tool for the central bank to control inflation, investment, and money supply in the economy.
Importance
The Statutory Liquidity Ratio (SLR) is a crucial finance term and serves as a key monetary policy instrument, playing a significant role in promoting financial stability.
Banks are obliged to hold a certain percentage of their net demand and time liabilities in the form of liquid assets, predominantly cash, gold, or government-approved securities.
This requirement, which is set by a country’s central bank—the Federal Reserve in the U.S., the Reserve Bank of India in India, for example—helps to ensure that banks have enough funds available to meet any immediate demands from depositors.
By maintaining an appropriate SLR, banks can reduce the risk of becoming insolvent during a period of business downturn or financial stress.
Moreover, it allows central banks to control credit expansion and guide the banking system towards a path that fuels sustainable economic growth.
Explanation
The purpose of the Statutory Liquidity Ratio (SLR) is to ensure the financial soundness and stability of financial institutions, predominantly banks, by regulating their credit growth and maintaining a sufficient degree of liquidity. By achieving this, financial institutions are better equipped to meet potential cash outflows stemming from unanticipated demands by depositors.
SLR serves as a preventive regulatory measure, compelling banks to hold a certain proportion of their net demand and time liabilities (NDTLs) in the form of liquid assets, such as cash, government securities, or other liquid securities. SLR also offers a strategic tool for central or reserve banks to control bank credit and interest rates.
By mandating certain liquidity levels, the authority can limit the extent to which a bank can leverage its deposit base to extend loans, thereby controlling the money supply in the economy. Updating the SLR rates allows these authorities to manipulate economic activity – if the economy is overheating, they might raise the SLR rate to inhibit bank lending, and conversely during slow economic periods, a lower SLR rate will inspire more lending and thus stimulate economic activity.
Examples of Statutory Liquidity Ratio
Reserve Bank of India (RBI): In the context of financial regulations in India, the Reserve Bank of India (RBI) mandates a certain percentage as a Statutory Liquidity Ratio (SLR). Commercial banks in the country need to maintain that percentage of their Net Demand and Time Liabilities (NDTL) in the form of gold, cash, or other approved securities. The SLR rate in India as of August 2021 is 18%.
Central Bank of Sri Lanka: Like the RBI, the Central Bank of Sri Lanka also demands commercial banks in the country to maintain a statutory liquidity ratio in order to control liquidity and inflation. The SLR guideline helps prevent the banks from liquidating and promotes economic stability.
Nepal Rastra Bank (NRB): Nepal’s central bank, the Nepal Rastra Bank, has set the statutory liquidity ratio at 20% for the fiscal year 2020/
Commercial banks are required to maintain this ratio, helping the NRB control inflation and stabilize the banking sector in the country.
FAQs about Statutory Liquidity Ratio
What is Statutory Liquidity Ratio (SLR)?
The Statutory Liquidity Ratio (SLR) is a reserve requirement that commercial banks in a country must maintain in the form of cash, gold reserves, government-approved securities before providing credit to its customers. It’s expressed as a percentage of total deposits and set by the banking regulation of the country.
Why is Statutory Liquidity Ratio necessary?
SLR is necessary because it helps maintain the economic stability of a country. By controlling the expansion of bank credit, It prevents the banks from going bankrupt and the economy from entering into a financial crisis. It also ensures that banks have sufficient funds to meet customer demands.
How is Statutory Liquidity Ratio calculated?
Statutory Liquidity Ratio is calculated as the percentage of total net demand and time liabilities (NDTL). NDTL is calculated as the total demand and time liabilities (deposits) a bank has subtracting from inter-bank liabilities or money owed to other banks.
How does the change in SLR affect the economy?
Changes in the SLR can have a significant impact on the economy. If the SLR is increased, the amount of money bank can use for investment or granting credit decreases, thus reducing the bank’s profits. On the other hand, if the SLR is decreased, the money available to banks for investment or lending to the public increases hence leads to economic development.
What is the difference between Statutory Liquidity Ratio and Cash Reserve Ratio?
The main difference between the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) is what they represent and how they’re used by the financial institution. While SLR refers to the amount that the banks should have as reserves in cash, gold, or approved securities, CRR refers to a portion of total deposits that banks are required to keep with the central bank. SLR controls credit expansion, while CRR ensures the liquidity and solvency of the banks.
Related Entrepreneurship Terms
- Reserve Requirement: This is the amount of funds that a bank is required to hold in reserve against specified deposit liabilities.
- Liquidity Management: The process of managing a company’s or an individual’s liquidity levels to meet short-term obligations.
- Monetary Policy: The process by which the monetary authority of a country, like the central bank, controls the supply of money in the economy.
- Bank Rate: The interest rate at which a country’s central bank lends money to commercial banks.
- Cash Reserve Ratio (CRR): The percentage of total bank deposits banks are required to keep with the central bank in the form of reserves.
Sources for More Information
- Investopedia: It is a reliable website that covers a broad subject matter from personal finance to trading. They have a dedicated page explaining the term Statutory Liquidity Ratio.
- The Balance: It provides comprehensive coverage of personal finance including more complex aspects, such as the Statutory Liquidity Ratio.
- Reserve Bank of New Zealand: As the central bank of New Zealand, a trusted authority on financial issues, they provide explanations and policies related to Statutory Liquidity Ratio.
- Reserve Bank of India: Being the central bank of India, this is another official and reliable source of information about the Statutory Liquidity Ratio, considering it’s a significant finance term in Indian banking regulations.
