The Statutory Liquidity Ratio that the RBI mandates for the banks, is like your father mandating you to force-save some money every month because he wants to regulate your net cash-in-hand. However, in the case of the Indian economy, this regulation is steered by the Reserve bank of India. Allow us to break it down for you.
How does a bank conduct its business?
For a bank, the concept of assets and liabilities may be reverse of what you’d imagine. You deposit money in banks via savings/current accounts, fixed deposits etc; and so do various businesses and industries. While you can withdraw money from your savings/current accounts on-demand, anytime you want; the same withdrawal from, say, a fixed deposit can be time-bound. If you have invested in an FD for 1 year, you may ideally want to wait for 1 year and then withdraw. The money that you get on withdrawal comes with some interest earned. Hence, these deposits become a bank’s liabilities, because this money needs to be provided to you whenever you wish to withdraw. The money in savings/current account (for example) is called a demand liability whereas money in a time-bound fixed deposit (for example) is called a time liability.
This money is used by the banks to provide loans to various people and organizations on which it earns some interest. Some of the deposited money can also be used by the bank for investment in other banks in order to earn more interests. And all these sources of inflow of money become the bank’s assets. Every bank uses its liabilities to lend out money as loans to borrowers.
The amount of money available to the bank for providing loans is called its
Net Demand and Time Liabilities (NDTL), which is basically, the sum of all the deposits made to the bank by people like you, less the amount that the bank has invested in other banks.
NDTL= All liabilities- deposits in other banks
What does NDTL have to do with SLR?
Now, suppose the NDTL for a bank is Rs 10 Lakh, does that mean that the bank can lend out the entire 10 Lakh in the form of loans? No. Because if that happens, then the bank will be left with no liquid money or buffer. Every business requires cash liquidity and to regulate that in case of banks, is the role of the Reserve Bank of India. The RBI mandates that a portion of this Rs 10 Lakh needs to be kept with the bank but in the form of liquid assets. Liquid assets are assets that are either cash or can be converted into cash easily, for example- Cash, Gold or Government securities etc. This percentage is called the Statutory Liquidity Ratio (SLR). In our example, if the RBI mandates the banks to maintain an SLR of 20%, then the bank will keep Rs 2 Lakh in liquid assets and will be able to loan out only the remaining Rs 8 Lakh. The amount of R 2 Lakh is like a safety net for the bank in case any crisis strikes.
The example stated above is for illustrative purposes only.
SLR= (Liquid assets mandated by the RBI/ NDTL)%
Why does RBI regulate the SLR for banks?
The RBI regulates the SLR in order to ensure just the right amount of money is available for lending, neither too much nor too less. The banks, in turn, earn interest on the SLR money they keep as liquid assets and see it as a buffer to safeguard themselves. Here’s is how SLR regulation affects the growth and inflation in our economy. Let us see how-
Hence, by lowering or increasing SLR %, the RBI can control inflation in the market. Simply put, assume that your monthly income is Rs 1 Lakh, your monthly expenditure is Rs 40,000 and compulsory savings are Rs 20,000. That leaves you with Rs 40,000 cash-in-hand that you can spend as per your will. Your SLR is 20% in this case. Now, if you increase the SLR to 50%, you are left with lesser money to spend (Rs 10,000), thus resulting in lesser demand for items that may not be needed or can be delayed. Just like you regulate your own life’s supply and demand, so does the RBI for our country.
How does SLR impact your
For the ease of discussion let us focus on Government securities. Now, assuming the RBI has increased the SLR, that would mean banks have to keep more money in liquid assets and hence, more banks will be scouting for Government securities to invest in. Clearly, the demand for G-Secs goes considerably up as they get difficult to acquire, and their prices will go up. If you, as an investor, want to invest in G-Secs, you will now find it a tad bit more difficult to buy them. Now, as is the case with anything that has a soaring demand, the benefits associated with it reduce. Hence, the interest % associated with the G-Secs will go down. If you had invested in a G-Sec before the SLR was enhanced, in the current situation, you will get more returns if you choose to redeem since now the cost of the bond has increased.
An increased SLR could mean better returns for debt investors.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.