Question

What is statutory liquidity ratio (SLR) called?

Hint:

SLR is a tool used by central banks to manage liquidity in the banking system. A higher SLR limits credit, while a lower SLR stimulates lending and economic growth.

Answer 1

Step 1: Defining Statutory Liquidity Ratio (SLR):
The Statutory Liquidity Ratio (SLR) is a minimum percentage of a commercial bank's net demand and time liabilities (NDTL) that it must maintain in the form of liquid assets, such as cash, gold, or government-approved securities. The central bank (in India, the Reserve Bank of India or RBI) sets the SLR, and it is a regulatory measure used to ensure that banks maintain a certain level of liquidity. The SLR is a tool used by central banks to control inflation and to ensure the stability of the banking system.
Step 2: Purpose and Function of SLR:
- Liquidity Management: The primary purpose of the SLR is to ensure that banks have sufficient liquid assets to meet withdrawal demands. By maintaining an adequate level of liquidity, banks can avoid situations where they might face a shortfall in funds for their customers' withdrawals.
- Controlling Credit Growth: By adjusting the SLR, central banks can influence the amount of money banks have available to lend. A higher SLR limits the funds available for lending, thus reducing credit growth in the economy. Conversely, a lower SLR increases the funds available for lending, stimulating credit and economic activity.
- Monetary Policy Tool: The SLR is a tool for the central bank to control inflation. If inflation is high, the central bank may increase the SLR to restrict credit flow, reducing inflationary pressures.
Step 3: How SLR Affects the Economy:
- Impact on Banks: A higher SLR means that banks have to set aside more of their funds in liquid assets, which limits their ability to lend. This can lead to higher interest rates and reduced borrowing by businesses and consumers. A lower SLR increases the potential for banks to lend and stimulate economic activity.
- Impact on Government Debt: The SLR mandates that a portion of banks' reserves be in the form of government securities. This requirement creates consistent demand for government bonds and helps the government finance its fiscal deficit at a lower cost.
Step 4: Final Conclusion:
The Statutory Liquidity Ratio (SLR) is a key regulatory tool that ensures liquidity in the banking system and allows the central bank to control credit growth and inflation. By mandating that banks hold a certain percentage of their liabilities in liquid assets, the SLR plays a vital role in maintaining financial stability.