SLR-Statutory Liquidity Ratio-Simplified

SLR:

 

“SLR Decreased from 24% to 23% with effect from 11/08/2012 by RBI”. 

This was the news published in the year 2012.

To understand the impact of the news on stock market, we first have to understand what SLR is.

SLR means- Statutory Liquidity Ratio.

It is a tool used by RBI to control inflation and to boost growth.

Since last 2 years, RBI's primary aim is to control inflation.

 

Objectives of SLR: The main objectives for maintaining the SLR ratio are the following:

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.

To compel the commercial banks to invest in government securities like government bonds.

SLR regulates credit growth in the country.
 

If RBI sets SLR to 25%, that a Bank must keep 25% of its Total deposits, into non-cash forms prescribed by RBI: that is….

1.            in Gold

2.            In Corporate Bonds / Shares approved by RBI

3.            G-Sec (Government Securities/ Treasury Bonds)

But most banks prefer to put all the money in Government securities (G-Sec), because they're safer than the other two.

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.

 

Bank must not give away all its loans to risky loan takers.

Banks must invest part of its money in safe and liquid investment.

So during emergency, bank can sell those liquid investments and take out the money.

For example, Government securities, gold, corporate bonds of reputed companies like L&T, reliance, TCS.

These are safe investments. These are also liquid, because you can sell them quickly whenever you want.

So, bank should invest part of common-men’s money in safe investments like Government securities, gold and corporate bonds of highly reputed companies.

BUT who will decide how much money should be invested by banks in safe investments?

 Answer is RBI via SLR (Statutory liquidity ratio). 

What happens if SLR is decreased/increased?

If SLR is decreased, then banks have more money to lend and they will charge less interest rate on loans to lure more customers.

If SLR is increased, then banks have less money to lend they’ll charge more interest rates on loans to keep the profit margin same.

So in the above mentioned news, the impact is banks have more money to lend i.e. more liquidity in the system and also banks will

Charge less interest rate. This is done to fuel the growth in the economy. 

Why it is called statutory liquidity ratio?

It is called Statutory because it is provided by the Law.(The RBI act)

This Act says SLR cannot be more than 40% and less than 25%.

But in 2007, Government amended the act and removed the lower limit of 25%, so thus RBI went to 24 and 23% SLR.