Statutory Liquidity Ratio

The statutory liquidity ratio (SLR) is the minimum percentage of liquid assets that every commercial bank needs to retain. It acts as a reserve and comprises cash, securities, and gold. It is evaluated as the percentage value of the bank's liquid assets divided by an aggregate of its net demand and time liabilities.

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.

• 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 = × 100.

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 banks 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.

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 economy.

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 instruments, and treasury bills.

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 deposits, 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 institution 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 = × 100

SLR = × 100 = 3.27%

By maintaining minimum retention of 3% SLR, XYZ bank fulfills Fed’s requirements successfully.

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.

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 – 

• Difference Between CRR and SLR
• Reserve Ratio
• Reserve Currency