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RBI uses many monetary policies for controlling and stabilizing the economy and one among them is SLR. The primary goal of the RBI is to make sure that prices of commodities are maintained at an optimum level and to administer the supply and demand of money flow into the economy. It uses instruments like credit ceiling, statutory liquidity ratio, cash reserve ratio, bank rate policy, open market operations, credit authorization scheme, repo rate, reverse repo rate, moral suasion, etc. Each of these instruments plays a significant role in operating the economy of the nation.
According to the Government of India, the commercial banks are required to maintain a certain amount of reserve to provide credit to their customers. This reserve can be in the form of cash, gold reserves and RBI approved securities. It is managed by a ratio determined by RBI, known as the statutory liquidity ratio. It is the ratio of liquid assets to demand and time liabilities. The Reserve Bank of India has the authority to increase the rate up to 40% which restricts the ability of banks to contribute money to the economy.
SLR's component includes net balance in the current account and investment in government securities, cash in hand, amount of gold owned by the bank etc. It is mandatory for all commercial banks to maintain SLR according to Section 24 and Section 56 of the Banking Regulation Act.
Time deposit includes the deposits that can be used on maturity, means that cannot be withdrawn by depositor immediately. He has to wait until the lock-in period is over to access his funds.
The SLR is considered as one of the references while determining the base rate (minimum lending rate). This is the minimum rate below which banks are not allowed to lend money. Its role is to check the transparency concerning transactions in the credit market. It also helps the bank to cut down on their cost of lending so that the banks will be able to offer loans at affordable interest rates. However, this condition also checks the lending capacity of the bank. To keep the demand in control, there is a need to increase the lending rates.
In India, every bank is supposed to maintain SLR. To ensure its maintenance, banks have to report their latest Net Demand and Time liabilities to RBI every fortnight Friday. If not maintained, RBI imposes a penalty of 3% over the bank's interest rate annually. In case of defaulting on the next working days too will lead to a penalty of 5%.
Banks have a specific component called risk capital. It includes funds used for high risk, high reward investment. It is crucial to invest in it wisely. This can result in a massive amount of gain or loss. So, the correct level of SLR would be equal to the level of the risk capital of any bank.
It is essential that these assets are reserved in a non-cash form which could be bonds, precious metals, and other government-approved securities.
| SLR | CRR |
|---|---|
| It deals with all the liquid assets including both cash and gold reserves | It deals with only cash reserves |
| Banks receive interest on SLR reserves | Banks earn no Interest on it. |
| The primary purpose is to control the bank's ability for credit expansion | The primary purpose is to control liquidity in the banking system |
| Reserve is held with the bank itself, which they need to keep in liquid asset form | Reserves are maintained by RBI |
The main reason behind SLR is to keep the banks safe from becoming a sick unit. Financial activity with any third person is a risky affair. In order to protect banks from any risk of getting sick, RBI imposes SLR and keeps a small amount of fund safe with it. You may wonder how SLR help in economic development. it has promoted and improved the debt management programme of the Indian government. This programme help banks to offer loans to all sectors of the economy.
Read More - Repo Rate & Reverse Repo Rate
