Statutory Liquidity Ratio (SLR) 1. 2. 3. 4. 5. 6. 7.

What is SLR? What happens if SLR is decreased? But why would SBI sell G-sec? SBI takes initiative Why is it called "Statutory" Liquidity Ratio? How does SLR reduction impact Bond Yield? SLR decrease unusual To put this without getting "technically correct" What the hell is SLR?

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SLR Means Self Loading Rifle. The INSAS Rifle used by our Jawans, is one example of SLR. But for our purpose, SLR means

Statutory Liquidity Ratio. It is a tool used by RBI to control inflation and to boost growth. Anyways since last one year, RBI's primary aim is to control inflation. If RBI sets SLR to 25%, that a Bank must keep 25% of its Total deposits, into non-cash forms prescribed by RBI: that is.

1. In Gold 2. In Corporate Bonds / Shares approved by RBI 3. G-Sec (Government Securities/ Treasury Bonds)

But most bank prefer to put all the money in Government securities (G-Sec), because they're more safe and convinient than the other two. What happens if SLR is decreased?

Earlier SLR was 24%, but on last day of July, RBI changed it to 23%. That means, if earlier SBI had total Rs.100 Deposited in all its 11,000+ branches, then SBI would have to park Rs.24 in G-sec but with new RBI rule, SBI will have to park only Rs.23. Meaning SBI can take away Rs.1 from its G-sec investment and use it for giving as loan to regular customers. So, SBI will sell G-sec worth Rs.1 from its suitcase and use that 1 Rupee for lending as House, Car, Business loans to the customers. SBI has one more rupee to lend to the customers, it'll reduce the interest rate (to seduce more customers). Thus Interest Rates go down when SLR is decreased. In real life, 1% decrease in SLR, means SBI alone will have additional Rs.10,000 crores for lending And all the banks (SBI, ICICI, Bank of Baroda etc combined), will have more than 68,000 crores for lending. Now the reverse: If SLR is increased, then banks have less money to lend = they'll charge more interest rates on loans to keep the profit margin same. But why would SBI sell G-sec?

Earlier I said, Banks prefer to park the SLR money into G-Sec, because it is safe and convenient. But when something is safe the rate of return (profit) is not high. In case of G-sec, the rate of return on G-sec is 7.5%, while if SBI lends the same money to customers- it can earn more than 10% (because car and home loans have more than 10% interest rate, usually.)

SBI takes initiative

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Just because RBI decreased SLR, doesn't mean all banks will immediately reduce the loan interest rates (Thank god they don't behave like Oil Companies- who have formed up sort of cartel, and then rarely reduce oil prices even if crude oil price decreases in global market.) Anyways, whenever RBI decreases rates, usually SBI takes the initiative and decreases interest rates to attract new customers. [Because SBI is a big player with deep pockets, it can suffer temporary losses to get new customers- just like Wallmart etc. do by offering huge discounts]. Other banks such as ICICI, will then have to reluctantly follow the suit, to keep up with the competition of SBI. For example, on 1st august 2012, SBI reduced its Car loan interest rate from 11.25 to 10.75% and Home loan interest rate from 10.50% to 10.25%. So now if ICICI wants to keep in business, it'll have to reduce its rates. [can't just rely on Bacchan's advertisement power.] Why is it called "Statutory" Liquidity Ratio?

It is called Statutory because it is provided by the Law/Statute(The Reserve Bank of India Act). This Act says SLR cannot be more than 40% and less than 25%. [hahaha, if SLR was 40% then who would open a bank in the first place?!] But in 2007, Government amended the act and removed the lower limit of 25%, so thus RBI went to 24 and 23% SLR. How does SLR reduction impact Bond Yield?

You already know what is Bond yield. If not, then go through the Eurozone Article. (Click Me) The Newpapers are reporting that Bond Yields increased after RBI cut down the SLR. So why or how did that happen? Think about it! SLR decrease unusual

Usually, RBI would try to manipulate the money supply in the market (and thus control inflation) by changing the repo rate, and SLR is kept unchanged, but this time, RBI kept the Repo rate unchanged and instead decreased SLR, why? Again, Think about it.