Understand the Statutory Liquidity Ratio (SLR), its role in India's monetary policy, and its impact on the banking system and credit flow

Statutory Liquidity Ratio (SLR) in India: Policy Usage and Impact in the 1980s and 1990s

• Definition and Function of SLR

  • The ratio of liquid assets to demand and time liabilities maintained by banks in India is known as the Statutory Liquidity Ratio (SLR).

  • Besides Cash Reserve Ratio (CRR), banks are mandated to hold liquid assets such as gold, cash, and approved securities.

  • A higher SLR forces banks to hold a greater proportion of their resources in liquid assets, thereby reducing their lending capacity. This has an anti-inflationary effect.

  • It also channels funds away from loans towards government and approved securities, influencing the structure of public sector financing.

• SLR Policy During the 1980s and 1990s

  • During the 1980s, the RBI increased the SLR to regulate liquidity and support public sector investment without creating reserve money.

  • In October 1981, SLR was increased from 34% to 35% in two phases.

  • From the fortnight beginning April 25, 1987, SLR was further raised to 37.5% of net demand and time liabilities.

  • Due to a surge in reserve money and falling food credit in December 1987, SLR was increased again to 38% starting January 2, 1988, to moderate liquidity while maintaining productive credit flow.

  • On October 16, 1993, the incremental SLR requirement was reduced from 30% to 25% for additional liabilities over the September 17, 1993 base level.

  • SLR was fixed at 34.75% for liabilities based on April 3, 1992 and September 17, 1993.

  • Effective October 14, 1995, banks were required to adopt a uniform system for valuing SLR securities for both SLR and balance sheet purposes.

  • From April 13, 1996, SLR on Non-Resident (External) Account (NRE) liabilities was reduced from 30% to 25% to rationalize overall SLR requirements.

  • From October 25, 1997, all scheduled commercial banks were mandated to maintain a uniform SLR of 25% on their net demand and time liabilities, the minimum required under Section 24 of the Banking Regulation Act, 1949.

  • The current SLR rate is 24%.

• Objectives and Impact of SLR

  • The key goal of SLR is to control the expansion of bank credit by regulating the proportion of liquid assets banks must maintain.

  • By adjusting the SLR, the RBI can influence credit creation by commercial banks and control inflation.

  • SLR helps ensure the solvency of banks by requiring them to hold safer assets such as government bonds.

  • The policy also compels banks to invest in government securities, aiding public borrowing and fiscal stability.

  • The RBI may raise SLR to curb excess liquidity and safeguard depositors' funds during inflationary phases.