What is the Full Form of SLR?
The full form of SLR is the Statutory Liquidity Ratio. It is termed as the ratio of the bank’s liquid assets to the net demand and time liabilities it owes. The liquid assets are composed of cash, gold, and other marketable securities. The statutory liquidity ratio is termed as the rational basis in which the central bank determines the minimum reserve requirements a bank aligned under it should meet up. The term statutory means that the bank is legally and mandatorily required to adhere to the central bank’s reserve requirements.
Objectives of SLR
- The central bank mandates commercial banks to maintain demand depositsDemand DepositsMoney deposited with a bank or financial institution that can be withdrawn without notice is known as a demand deposit. Due to the shorter lock-in time, it does not pay any interest or a nominal amount of interest. and liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company's balance sheet. in the independent vault.
- The ratio helps in establishing the monetary policy for the nation.
- The central bank establishes this ratio between 40 percent for upper cap and 23 percent in a lower cap.
- The ratio is instrumental in restricting the commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits. from liquidating their assets beyond a specified threshold.
- If the ratio is not set or established, then the banks or the financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. may resort to over liquidation of assets and could, in turn, jeopardize its financial health.
- The SLR ratio helps in establishing and controlling the bank credit. The central bank would specifically modify the ratio when there is a marked change in inflation levels.
- When there is a rise in inflation, the bank raises the SLR ratio, which in turn restricts the bank credit.
- When there is a recession in the economy, the bank reduces the SLR ratio, which raises the bank credit.
Components of SLR
The statutory ratio has two broad components, namely: –
#1 – Liquid Asset
These are assets that can be liquidated within 1 to 2 days into cash. Such assets are normally composed of cash equivalents, gold, treasury billsTreasury BillsTreasury Bills or a T-Bill controls temporary liquidity fluctuations. The Central Bank is responsible for issuing the same on behalf of the government. It is given at its redemption price and a discounted rate and is repaid when it reaches maturity., government bonds, securities, and marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it..
#2 – Net Time and Demand Liabilities
These are deposits that the banks or financial institutions accept from the banks. The banks are liable to pay such entities on demand. The NTDL is composed of demand drafts, overdue fixed deposits, demand drafts, and saving deposits along with time deposits having varying maturities. The depositors of the time deposits are unable to liquidate their deposits until they reach maturity, and if such deposits are liquidated before maturity, the bank levies penalties on such withdrawals on the deposit holders.
How Does SLR Work?
- The financial system of the nation is governed by financial intermediaries and market participants. The central bank is the financial institution or financial intermediary, which has the exclusive rights to produce and distribute funds across different parts of the nation. They get exclusive rights from the governments of the nation. In India, the role of a central bank is portrayed by the Reserve bank of India, whereas, for the US, the role is portrayed by the federal reserve.
- Commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits. operating in a different part of the nations reports to the central banks. The central bank monitors and supervises the performance of the commercial banks aligned to it. To ensure compliance and performance standards among commercial banks, the central bank establishes a statutory liquidity ratio.
- The bank has to hold certain percentages of cash and gold to meet up the net demand and time-based liabilities. The central bank establishes this ratio, and all the commercial banks aligned to it have to comply with the set ratio. If the ratio appreciates, then the bank narrows the flow of money into the economy. The statutory liquidity ratio helps in governing the monetary policy, and it ensures that the commercial banks are solvent.
How to Calculate SLR?
The formula for calculating the Statutory liquidity ratio is expressed as shown below: –
- A liquid asset is represented as LA.
- Net time based and demand liabilities are represented as NTDL.
Let us take the example of ABC Bank. The bank holds liquid assets worth $20 million. The bank has NTDL or net time and demand liabilities of worth $200 million. Help the management of ABC bank on the determination of the statutory liquidity ratio.
Determine the SLR ratio as displayed below: –
- = $20,000,000 / $200,000,000
- = 20 / 200
- = 1 /10
- = 0.1
Statutory liquidity Ratio = 10 %.
Therefore, the bank has an SLR ratio of 10%.
- The impact of SLR is immense as it regulates the flow of funds in the economy as it fixes the base rate. The base rate is the rate established by the central bank below, in which the commercial banks are forbidden to lend funds to the borrowers. The base rate, therefore, promotes transparency over lending and borrowing business.
- The statutory liquidity ratio ensures that some portion of deposits would always remain safe, and it would be readily provided to the deposit holders if they redeem the deposits in the event of failure of the financial system. To ensure the SLR remains competitive, the bank has to report its net time and demand liabilities on a fortnight basis.
- If the commercial banks aligned under the purview of the central banks fail to comply with the statutory liquidity ratio, then the commercial bank has to pay a fine of three percent over and above the bank rate to the central bank on an annual basis. Additionally, any defaults on the immediate working day result in a 5 percent penalty on the commercial banks.
Difference between SLR and CRR
- The CRR stands forCRR Stands ForCRR stands for Cash Reserve Ratio and refers to the share of the total deposit of the commercial banks, which they have to keep with the central bank in the form of liquid cash that the central bank uses to control the liquidity in the banking system. the cash reserve ratioCash Reserve RatioCash Reserve Ratio refers to the share of a Bank’s total deposits that need to be maintained with the respective Country’s Central Bank to control financial supply in the economy. .
- The cash reserve ratio only focuses on the cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. that the commercial banks maintain with the central banks.
- The statutory liquidity ratio is composed of cash, golds, treasury securities that the commercial bank has to maintain with the central banks.
- The statutory liquidity ratio focuses on the commercial bank’s ability to extend credit to borrowers.
- The cash reserve ratio focuses on the central bank’s ability to extend credit to the commercial banks, and hence central banks control the money supply in the commercial banking system with the help of CRR.
- Commercial banks earn interests on liquid assets kept with the central banks for complying with the SLR guidelines, whereas the commercial banks never earn interest on cash reserves maintained with the central bank.
- The cash reserve ratio monitors the flow of money in the economy, whereas the statutory liquidity ratio helps commercial banks meet up the holders of deposits’ demands.
The statutory ratio has to maintain by all the commercial banks reporting to the central banks. The central banks review the economic situation of the country regularly and accordingly modifies the statutory liquidity ratio. If the central bank raises the SLR, then it means that the central bank wants the commercial bank to limit the availability of the bank limit.
The ratio ensures that the bank can service the demands of the deposit holders if the holder liquidates the deposits that it had given to the commercial bank. If the commercial banks fail to comply with the statutory liquidity ratio, then it has to bear fines and penalties for not complying as imposed by the central banks.
This has been a guide to the full form of SLR (Statutory Liquidity Ratio). Here we discuss objectives, components, and how to calculate SLR along with its impact. You may refer to the following articles to learn more about finance –