What is it?
SLR is one of the many arrows in the RBI’s monetary policy quiver. These are used, sometimes in isolation, sometimes in combination, to manage money supply, interest rates and credit availability in the country. The SLR may not be as talked-about as its flamboyant cousins, the repo rate and the cash reserve ratio (CRR) but it packs quite a punch too, in its own quiet way.
The repo is the rate at which banks borrow short-term money from the RBI and the CRR is the percentage of deposits banks have to hold as cash reserves with the RBI. SLR is that portion of deposits banks have to hold with themselves in highly liquid government securities.
Why these reserve requirements? Primarily to ensure that banks always have enough liquidity (cash and cash equivalent securities) to honour depositor’s demands and that they don’t lend away all their funds. So, banks have to keep 4 per cent of their total deposits as CRR with the RBI.
They also need to invest, as SLR, another 20 per cent now (from 20.5 per cent earlier) of their total deposits in government securities. These reserves are also used by the RBI to tighten or ease monetary conditions in the economy. For instance, now, the 50 basis points reduction in SLR leaves more money with banks to lend. If, in the future, the RBI wants to reduce money supply, it can raise SLR thus leaving banks with lesser funds to lend.
Over the years, the use of CRR and SLR as instruments of monetary control has been reduced. From 37-38 per cent in the early 1990s, the RBI has reduced the SLR to 20 per cent now. But this is still significant to influence credit and rates.
Why is it important?
The RBI doesn’t always prefer bringing out the big guns in its monetary tools armament for fear of causing collateral damage — read, the risk of stoking inflation due to a repo rate cut. In such situations, SLR can be an effective pistol, so to speak. Reducing SLR can free up banks’ funds, which if deployed for lending can boost investment cycle. The RBI lowering SLR this time was broadly seen as an attempt to revive the slack credit demand in the economy.
But banks may not loosen up their kitty immediately, this time around. That’s because banks prefer to carry excess investments and park funds in highly safe assets, particularly when lending opportunities are weak. Currently, banks on an average continue to invest 3-5 per cent more than the mandated SLR requirement.
Why should I care?
SLR tweaks can impact your borrowing rates. Wondered why the RBI’s rate actions don’t seem to make much difference to your borrowing rates? One of the reasons cited for this poor monetary transmission is the ready market for bond buybacks by the RBI through open market as well as through the SLR mandate.
This, the Urjit Patel Committee believes has kept rates on government borrowing suppressed. To facilitate quicker transmission of policy rates to borrowers, it is essential to align interest rates across different segments to market-determined rates. The RBI has been reducing SLR in a phased manner over the past one to two years, to ensure better transmission by doing away with a captive market for government securities. This should make the bond yields reflect actual market demand.
The bottomline
The RBI’s ratios and your rates — it’s an effective bond.