Previous Year Question
When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen?
India’s GDP growth rate increases drastically.
Foreign Institutional Investors may bring more capital into our country.
Scheduled Commercial Banks may cut their lending rates.
It may drastically reduce the liquidity in the banking system.
Correct Answer: C
Detailed Solution
The Statutory Liquidity Ratio, or SLR, is the minimum percentage of a bank’s Net Demand and Time Liabilities that it must maintain in specified liquid assets.
These assets principally include:
cash;
gold; and
unencumbered approved securities, primarily including government securities.
One basis point equals one-hundredth of a percentage point:
1 basis point = 0.01%
Therefore:
50 basis points = 0.50 percentage point
Option (c) is correct.
A reduction in the SLR requires banks to maintain a comparatively smaller part of their deposits in mandatory liquid assets. This may release more funds for lending or other permitted activities.
Greater availability of lendable resources may reduce the funding constraint faced by banks. If competition and credit demand are favourable, Scheduled Commercial Banks may reduce their lending rates.
The expression “may cut” is important. A reduction in lending rates is not automatic after an SLR reduction. It also depends upon the bank’s cost of funds, credit risk, demand for loans, capital adequacy and prevailing market conditions.
Option (a) is incorrect.
An SLR reduction may support credit and investment, but it does not necessarily cause an immediate and drastic increase in GDP growth. Economic growth depends on several factors, including consumption, investment, government expenditure, exports, productive capacity and global conditions.
Option (b) is incorrect.
FII capital flows are influenced by global interest rates, the exchange rate, yields on Indian securities, risk perceptions and policy stability. Higher FII inflows are not the direct and most likely result of a 50-basis-point reduction in the SLR.
Option (d) is incorrect.
A reduction in the SLR is likely to increase rather than reduce available banking-system liquidity because a smaller proportion of bank funds remains locked in mandatory SLR assets.