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Posted by: Deepa Vasudevan on Mon, Aug 6th, 2012

The Prudent Reserve Bank of India

The Reserve Bank of India cut the Statutory Liquidity Ratio (SLR) by 1% with effect from August 11, 2012. Banks are now required to hold a minimum of 23% (as against 24% earlier) of their Net Demand and Time Liabilities in government and other approved securities.  The keyword here is "minimum"- there is, obviously, no upper limit on SLR investment. Over the past five years, bank holding of SLR securities has hovered around 30%, a clear 5-6% over the mandated norm (See Pic 1). The latest data, for the week ending July 13, shows that Scheduled Commercial Banks collectively had an investment-deposit ratio of 30.5%1.


Pic 1 What banks invest in SLR, and What they are supposed to

What banks invest in SLR, and What they are supposed to


The monetary policy is unlikely to reduce investment in SLR securities. The only scenario under which banks could drastically cut SLR holdings would occur if there was a huge credit upsurge. Given the slowdown in industry and services, and the poor monsoon, this is quite a remote possibility.


Then what does an SLR cut aim to achieve?  The reduction in SLR is a bit like taking insurance- not very useful in normal times, but a blessing when disaster strikes. The RBI policy has been planned for the second half of FY2013, when credit tends to pick up (busy season) and liquidity tends to be sucked out due to payment of advance taxes. In addition, government finances may be under strain if no policies are implemented to reduce the fiscal deficit. One has to go back only as far as September 2011- when hints of a larger-than-expected fiscal deficit pushed government yields up and led to rupee depreciation- to understand how quickly liquidity in money and forex markets can dry up.


By reducing SLR rate, two risks have been somewhat insured against. First, around 55,000 crore of liquidity is potentially available to the banking sector. That is, banks have the option (though not the compulsion) to liquidate at least 1% of their NDTL to meet any credit demand that may arise in the busy season. Only securities beyond the SLR limit are permitted for use in repo auctions, so banks now have more repo-able securities available at existing investment levels. Second, the indirect injection of liquidity may come in handy if RBI is forced to sell dollars to stem future rupee depreciation. Both possibilities, if they come to pass, can worsen macro-economic numbers and further damage India’s image as an investment-worthy nation.  By arming banks with more liquidity, RBI has tried to fortify them against another liquidity crisis. This policy may not be path-breaking, but it is prudent.


1In computing Investment-deposit ratio, the numerator is defined as bank holdings of g-secs and SLR approved securities. The denominator is aggregate deposits, not Net Demand and Time Liabilities, as in SLR ratio. Though the two are not strictly comparable, the difference is not likely to be significant.



Ramesh Kumar Nanjundaiya on Thu, Aug 9th, 2012 7:45:32 pm

There are 2 ways of looking at this. How much is the current global economic situation affecting the India economy directly and indirectly and how best the RBI is managing the situation. Was the reduction of SLR by 1% timely and sufficient. My personal feeling is that this is the best RBI could have done as of now. Let's not forget the ongoing euro zone sovereign debt problem, including the latest Greek economy and the Spanish economic issues and the support it has received by the Eurozone (ECB) by way of liquidity injection. Banking sector there is in shambles first by the recent Libor Scandal, Barclays Bank, et al and the latest US exposure of banks regarding Iranian business, etc. Going forward, all these raise concern about the future of banking sector and Euro debt problems which will have an indirect negative impart (small) on the Indian economy. Latest economic indications show that growth is slowing down across the globe in 2011-2012 including India which is highly dependent on monsoon. The first to rock the economy is the direct impact on reduced capital flows to Indian going forward and the affect of monsoon on commodities . This shows that inflation in the country will go for a six in the next 6 months. Added to this, the demand/supply imbalance situation is increasing by the day and there seems to be is no proper control mechanism. One can go on adding the current "scams", "black money economy" to this list which is helping to pull down the country's economically month on month. Added to this, no one seems concerned about the dwindling investments in public and private sector of the economy. With such a situation today, the only sane thing the RBI could have done was to reduce SLR by 1%. If one can translate this 1% in money terms, then banks will have extra cash to lend in the hope this will perhaps help revive (very marginally) the economy in the short term.

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