What is the Full Form of SLR?

The full form of SLR is the Statutory Liquidity Ratio. It is the ratio of the bank’s liquid assets to the net demand and time liabilities it owes. The liquid assets are cash, gold, and other marketable securities. The statutory liquidity ratio is the rational basis on which the Central Bank determines the minimum reserve requirements a bank aligned under it should meet. 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banks to maintain demand depositsDemand DepositsMoney deposited with a bank or financial institution that can be withdrawn without notice is known as a demand deposit.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.read more 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.read more in the independent vault.The ratio helps in establishing the monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more for the nation.The Central Bank establishes this ratio between 40 percent for the upper cap and 23 percent for the 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.read more from liquidating their assets beyond a specified threshold.If the ratio is unset or established, 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. read more may resort to over-liquidating assets and could, in turn, jeopardize their financial health.The SLR ratio helps in establishing and controlling the bank creditBank CreditBank credit is usually referred to as a loan given for business requirements or personal needs to its customers, with or without a guarantee or collateral, with an expectation of earning periodic interest on the loan amount. The principal amount is refunded at the end of loan tenure, duly agreed upon, and mentioned in the loan covenant.read more. The Central Bank would modify the ratio when there is a marked change in inflation.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’s credit.

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Components of SLR

The statutory ratio has two broad components, namely: –

#1 – Liquid Asset

These assets can liquidate within 1 to 2 days into cash. Such assets normally consist of cash equivalents, gold, treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more, government bonds, 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.read more.

#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 comprises demand drafts, overdue fixed deposits, demand drafts, and saving deposits, along with time deposits having varying maturities. The depositors of the time deposits cannot liquidate their deposits until they reach maturity. If such deposits are liquidated before maturity, the bank levies penalties on such withdrawals on the deposit holders.

How Does SLR Work?

  • Financial intermediaries and market participants govern the financial system of the nation. The central bank is the financial institution or intermediary with 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 Reserve bank of India portrays the role of a Central Bank. Whereas, for the US, the Federal Bank portrays the role.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.read more operate in different parts of the nation and report to the Central Banks. The Central Bank monitors and supervises the performance of the commercial banks aligned to it. In addition, the Central Bank establishes a statutory liquidity ratio to ensure compliance and performance standards among commercial banks.The bank has to hold certain cash and gold percentages to meet 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, the bank narrows money flow into the economy. The statutory liquidity ratio helps govern the monetary policy and ensures that the commercial banks are solvent.

How to Calculate SLR?

Below is the formula for calculating the Statutory Liquidity Ratio: –

Here,

  • A liquid asset represents LA.Net time-based and demand liabilities represent NTDL.

Examples

Let us take the example of ABC Bank. The bank holds liquid assets worth $20 million. On the other hand, the bank has NTDL or net time and demands liabilities 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%.

Impact

  • The impact of SLR is immense as it regulates the flow of funds in the economy and fixes the base rate. The Central Bank below establishes the base rate, in which the commercial banks forbid lending funds to the borrowers. The base rate, therefore, promotes transparency in the lending and borrowing business.The Statutory Liquidity Ratio ensures that some portion of deposits would always remain safe. One would readily provide it 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 fortnightly basis.Suppose the commercial banks aligned under the purview of the Central Banks fail to comply with the Statutory Liquidity Ratio. In that case, the commercial bank must pay a fine of three percent annually over and above the bank rate to the Central Bank. 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.read more 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. read more.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. read more that the commercial banks maintain with the central banks.The statutory liquidity ratio comprises cash, gold, and 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 commercial banks. Hence, the Central Bank controls the money supply in the commercial banking system with the help of CRR.Commercial banks earn interest on liquid assets kept with the Central Bank to comply with the SLR guidelines. In contrast, 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 the holders of deposits’ demands.

Conclusion

The Statutory Liquidity Ratio has to be maintained by all the commercial banks reporting to the central banks. The central banks regularly review the country’s economic situation and modify the statutory liquidity ratio accordingly. If the Central Bank raises the SLR, 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 commercial banks fail to comply with the Statutory Liquidity Ratio, they have to bear fines and penalties for not complying as imposed by the central banks.

This article guides the full form of SLR (Statutory Liquidity Ratio). Here, we discuss objectives, components, and how to calculate SLR and its impact. You may refer to the following articles to learn more about finance: –

  • BIS Stands For?Reserve RequirementBalance Sheet of a BankDifference Between CRR and SLR