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Difficulty: MediumMonetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets

When the Reserve Bank of India increases the Statutory Liquidity Ratio (SLR) for commercial banks, which of the following is the immediate effect on the banking system?

  1. The lendable resources available with commercial banks for credit expansion decrease.Answer
  2. B
    The cash reserves that commercial banks are required to maintain directly with the Reserve Bank of India increase.
  3. C
    The money multiplier in the banking system increases, boosting overall credit creation.
  4. D
    The overall market interest rates automatically decline due to excess liquidity in commercial banks.

Answer

The lendable resources available with commercial banks for credit expansion decrease.
Raising the Statutory Liquidity Ratio obligates commercial banks to hold a greater portion of their Net Demand and Time Liabilities in approved liquid assets (primarily Government Securities). Because more capital is locked into these specified assets, the amount of cash remaining for commercial lending and credit creation directly contracts.

Step-by-Step Solution

1
Define Statutory Liquidity Ratio (SLR)
SLR is the mandatory percentage of Net Demand and Time Liabilities (NDTL) that commercial banks must maintain in liquid assets (such as government securities, gold, or unencumbered cash).
Understanding the definition helps determine where the money goes when SLR changes.
2
Analyze the impact of increasing SLR on bank funds
When RBI raises the SLR, banks must invest a higher proportion of their deposits into eligible liquid assets.
Higher mandatory investments reduce the residual funds that can be deployed as loans and advances.
3
Conclude liquidity impact
Lendable resources contract, reducing bank credit expansion in the economy.
Fewer unencumbered funds are available for commercial lending.

Key Concept

Statutory Liquidity Ratio (SLR) and Bank Liquidity Transmission
Estimated Time:1m 0s
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Topics

Monetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets