The RBI Act instructs that all commercial banks (and some other specified institutions) in the country have to keep a given proportion of their demand and time deposits (NDTL or net demand and time liabilities) as liquid assets in their own vault. This is called statutory liquidity ratio.
The word statutory here means that it is a legal requirement and liquid asset means assets in the form of cash, gold and approved securities (government securities).
The RBI itself gives periodic updates about which assets are qualified as liquid assets under SLR. Similarly, it also gives institution specific guidelines for SLR to be kept.
Which institutions are required to keep SLR?
The SLR is an important regulatory requirement for the Scheduled Commercial Banks (SCBs) as they are the most dominant players in the financial system. But certain other institutions are also required to keep the SLR. The institutions which are required to keep SLR are:
All Commercial Banks (Scheduled and non scheduled), Primary (Urban) Co-operative Banks (UCBs), State and Central Cooperative Banks.
SLR is expressed as a percentage of Net Demand and Time Liabilities (NDTL) of banks. Put simply, SLR is expressed as a percentage of deposits. As on December 29, 2015, the SLR is 21.5% for commercial banks. RBI has brought a time table to reduce it to 20.5% by January 2017. Similarly, this rate will be common for all applicable institutions.
What is the purpose of SLR?
Theoretically, SLR is a monetary policy instrument (a direct instrument). But at the practical level, SLR has helped the government to sell its securities or debt instruments to banks. During the pre-reform period the SLR was 38.5%. Here, banks have to spend 38.5% of their deposits to purchase government securities.
There are couple of points that makes the SLR important for the government to make its debt management programme successful though the SLR is a monetary policy instrument at the table of the RBI.
Most of the banks will be keeping their SLR in the form of government securities as it will earn them an interest income. The average interest rate (yield) for a ten year old bond in India is around 8.5% now.
As the SLR is a statutory requirement and banks prefer to keep their SLR in the form of income earning securities, government can easily sell its bonds to the banks. This means SLR has facilitated government’s debt management programme. Securities above the SLR limit will be eligible from accommodation (temporary loan) under RBI’s repo. Understandably, all banks will be keeping government securities above the SLR level so that it can avail immediate money from the RBI by submitting it under the Repo. Usually, commercial banks in India hold around 25 to 30% of their NDTL in the form of government securities.
Present direction of SLR reform is to gradually reduce it so that banks can give higher level of loans to the private sector.
Difference between SLR and CRR
Cash Reserve Ratio is the percentage of the deposit (NDTL) that a bank has to keep with the RBI. CRR is kept in the form of cash and that also with the RBI. No interest is paid on such reserves.
On the other hand, SLR is the percentage of deposit that the banks have to keep as liquid assets in their own vault.
The CRR is a more active and useful monetary policy weapon compared to the SLR. Nowadays, the RBI changes CRR to manage liquidity in the economy.
Assets eligible under SLR
The eligible assets for SLR mainly include cash, gold and approved securities by the RBI. Most banks keep the SLR in the form of approved securities specifically –central government bonds and treasury bills as they give a reasonable return.
As per December 10, 2015 notification by the RBI, for Scheduled Commercial Banks, the SLR should be in the form of:
a) in cash, or
b) in gold valued at a price not exceeding the current market price, or
(c) Unencumbered investment in any of the following instruments, namely:-
(1) Dated securities of the Government of India or
(2) Treasury Bills of the Government of India; or
(3) State Development Loans (SDLs) of the State Governments
(d) The deposit and unencumbered approved securities required to be made with the Reserve Bank by a banking company incorporated outside India;
(e) Any balance maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be maintained by it under section 42 of the Reserve Bank of India Act.