What is the Statutory Liquidity Ratio (SLR)?

The SLR is mandatory as it ensures the solvency of the commercial bank. However, any rise in the ratio restricts banks from adding money to the economy. The SLR rate is a monetary policy that is used as a fiscal measure to regulate the economy.

Key Takeaways

  • The statutory liquidity ratio (SLR) is a minimum percentage of liquid assets that every commercial bank is required to maintain. Commercial banks are eligible for lending only if they fulfill SLR.The central bank has the power to change the SLR for regulating bank credit and for correcting the economy–during inflation, recession, or deflation scenarios.SLR is computed by the following formula: SLR = [Liquid Assets / (Net Demand + Time Liabilities)] × 100.

Statutory Liquidity Ratio Explained

A statutory liquidity ratio (SLR) is a percentage of liquid assets that a commercial bank or financial institution must retain daily. It acts as a reserve. This is the minimum requirement limit set by a central bank—commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.read more have to adhere to it.

For example, in the US, the SLR for commercial banks is set by the Federal Reserve. Banks that hold more than $250 billion in overall consolidated assets are required to retain a minimum of 3% SLR (also knowns as supplementary leverage ratio).

The SLR is also used as a monetary policy measure. The central bank regulates bank credit to control the supply of money. To tackle inflation, the central bank can raise the SLR to reduce bank credit. This, in turn, reduces cash flow in the economy.

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Similarly, during a recession, the central bank exercises expansionary monetary policy—it eases SLR to ensure the free flow of bank credit. Ultimately, the induction of money supply in the market boosts the overall economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more.

Objectives

SLR serves the following purposes:

  • SLR plays a key role in regulating the money supply.SLR is used as a reference ratio to determine lending or base rate. Commercial banks are not allowed to lend money below the base rate.SLR is essential for ascertaining the solvency and security of a commercial bank—to prevent over-liquidation.It encourages commercial banks to contribute toward government securities, debt instrumentsDebt InstrumentsDebt instruments provide finance for the company’s growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more, and treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more.

Formula and Calculation

The following formula is used for computing the statutory liquidity ratio:

Statutory Liquidity Ratio = (Liquid Assets)/(Net Demand+Time Liabilities)×100

SLR formula includes the following elements:

  • Liquid Assets: These assets can be readily converted into cash. Gold, treasury bills, government-approved securities, government bonds, and cash reserves are liquid assets.Net Demand: The net demand of a commercial bank depends on on-demand liabilities like demand draft, current deposits, overdue fixed deposit balance, etc.Time Liabilities: Time liabilities refer to long-term deposits, where banks need to repay their customers upon maturity. Fixed deposit accounts, staff security deposits, savings bank deposits, certificates of depositsCertificates Of DepositsA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period.read more, investment deposits, and call money market borrowings are time liabilities.

Now, let us look at a hypothetical to understand how SLR is calculated:

XYZ Bank is a US-based financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more holding liquid assets worth $278 billion. This includes cash, gold, and other securities. The bank also has a net demand of $1900 billion and time liabilities amounting to $6600 billion. If the Fed’s current SLR requirement is 3%, determine whether the bank fulfills requirements?

Solution:Statutory Liquidity Ratio = [(Liquid Assets) / (Net Demand + Time Liabilities)] × 100

SLR = [(278000000000 / (1900000000000 + 660000000000)] × 100 = 3.27%

Example

Let us now look at a real-world example of SLR.

From 1971 to 1980, The Bank of England (Central bank of the United Kingdom), mandated every commercial bank across England to maintain an SLR of 1.5% (of the total fund held by the banks). The banks agreed and retained assets in the form of cash and gold.

In 1999, The Bank of England mandated a cash reserve ratio of 0.15% approximately.

Impact on Investor

SLR is used as a reference rate for determining the base rate, i.e., the interest percentage at which financial institutions extend loans. Commercial banks are not allowed to extend loans below that interest rate. In doing so, the central bank sets the bar for affordable credit. Thus, SLR brings transparency and discipline to credit market operations.

The central bank ensures that commercial banks maintain sufficient solvency by reserving a percentage of deposits to pay off clients immediately. When the SLR is high, the banks are forced to block a significant portion of their liquid assets, which restricts the lending of funds to customers.

This has been a guide to what is Statutory Liquidity Ratio and its meaning. We explain its formula, examples, and its impact on investors. You can learn more from the following articles – 

The SLR of a commercial bank is evaluated as the percentage value of the bank’s liquid assets divided by an aggregate of its net demand and time liabilities. It is computed using the following formula:SLR = [Liquid Assets / (Net Demand + Time Liabilities)] × 100.

In the US, the Federal Reserve prescribes a minimum of 3% supplementary leverage ratio for financial institutions that hold more than $250 billion in total consolidated assets.

SLR is the percentage of liquid assets or deposits a financial institution must retain for net demand and time liabilities. The cash reserve ratio (CRR), on the other hand, refers to the percentage of net demand and time liabilities that a financial institution needs to maintain with the central bank in reserves or deposits.

The Federal Reserve ascertains the SLR or supplementary leverage ratio in the US.

  • Difference Between CRR and SLRDifference Between CRR And SLRThe cash reserve Ratio (CRR) is a percentage of money kept by all the banks with the Reserve Bank of India as cash to regulate the flow of money in the economy. In contrast, the statutory liquidity ratio is the time and demand liabilities to maintain bank solvency.read moreReserve RatioReserve RatioThe reserve ratio is the minimum percentage of the amount defined by the central bank to park aside by every commercial bank. The Central Bank can change this ratio depending upon the economic environment. read moreReserve Currency