The Reserve Bank of India (RBI), while announcing its fifth bi-monthly policy on Wednesday, proposed to reduce the Statutory Liquidity Ratio (SLR) by 25 basis points every calendar quarter until it reaches 18 percent of Net Demand and Time Liabilities. One basis point is one-hundredth of one percentage point, i.e. 0.01 percent. The first reduction of 25 basis points will take effect in the quarter commencing January 2019.
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By definition, SLR is the reserve requirement that the commercial banks in India are required to maintain in the form of cash, gold reserves, government-approved securities before providing credit to the customers.
Why is the SLR being cut?
The SLR is being cut in order to align it with the Liquidity Coverage Ratio (LCR) requirement. LCR refers to highly liquid assets held by banks to fulfill their short-term obligations.
It will also rationalise the extant framework for external commercial borrowings and rupee-denominated bonds with a view to improving the ease of doing business.
So, what does this mean for the banks and consumers?
CRR and SLR are used by the central bank to control the cash flow in the economy.
The norm requires the banks to invest a certain percent, currently 19.5 percent, in specified financial securities like central government or state government securities.
If the rate falls, the bank gets more resources to lend and therefore, it helps in the credit growth. This can encourage banks to reduce their interest rates on loans in order to boost borrowing which in turn helps economic growth.
Simply put, the reduction in SLR means the required amount to be kept with banks will be lower than the previous one and the banks will have more cash to lend. Similarly, if the SLR rate increases, the bank will be required to keep more funds under the norm and will have to restrict their lending.
For example, if you deposit Rs 1,000 in a bank, the bank will be required to keep a part of your deposit with the central bank as SLR. Taking the current rate, which is 19.5 percent, the bank will deposit Rs 195 in government securities.