Tuesday, April 12, 2016

Statutory Liquidity Ratio and Its Calculation

Statutory liquidity ratio (SLR)
Statutory liquidity ratio refers to the amount that the commercial banks require to maintain in the form of gold or government approved securities before providing credit to the customers.  Statutory Liquidity Ratio is determined and maintained by the Reserve Bank of India in order to control the expansion of bank credit. It is determined as % of total demand and time liabilities. Time Liabilities refer to the liabilities, which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon and demand liabilities are such deposits of the customers which are payable on demand. The maximum limit of SLR is 40% and minimum limit of SLR is 23% In India.
If any Indian bank fails to maintain the required level of Statutory Liquidity Ratio, then it becomes liable to pay penalty to Reserve Bank of India. The defaulter bank pays penal interest at the rate of 3% per annum above the Bank Rate, on the shortfall amount for that particular day. But, according to the circular, released by the Department of Banking Operations and Development, Reserve Bank of India; if the defaulter bank continues to default on the next working day, then the rate of penal interest can be increased to 5% per annum above the Bank Rate.
The main objectives for maintaining the SLR ratio are the following:
1)      To control the expansion of bank credit. By changing the level of SLR, the Reserve Bank of India can increase or decrease bank credit expansion.

2)      To ensure the solvency of commercial banks.
3)      To compel the commercial banks to invest in government securities like government bonds.
Formula for Calculating SLR in India: SLR rate = (liquid assets / (demand + time liabilities)) × 100%
 How does SLR affect economy?
Lower SLR, means bank can give more money as loan = lower interest rates = cheap loan = more people take loan to start business or building house or buying car = boost in economy. This could to inflation, if people have more cash in their hands than the items available for purchase in the market.
Higher SLR = bank can give less money as loan = Higher interest rate = it becomes expensive to start a new factory, buy a new house / car/bike. This can curb inflation but may also lead to slowdown in economy, because people wait for the interest rates to go down, before taking loans.