Question 81 from UPSC CSE 2015 - Economy

Question

When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen?

IASCODEX · Accepted Answer

Correct Option: C. Scheduled Commercial Banks may cut their lending rates

Strategy: The strategy is to focus on the direct impact of lowering the Statutory Liquidity Ratio (SLR). A lower SLR reduces the liquid assets banks must hold, freeing up capital for lending. This increased lending capacity is the most probable cause for a reduction in lending rates. Other factors, such as drastic GDP growth or foreign capital flows, are considered less direct and are therefore excluded.

Key Info: The Statutory Liquidity Ratio (SLR) is a key monetary policy tool in India's banking system.

**What is SLR?**
It is the proportion of deposits that scheduled commercial banks must maintain as liquid assets, such as cash, gold, and approved securities. This requirement is mandated under Section 24 of the Banking Regulation Act, 1949.

**Purpose and Effect**
*   **Liquidity Cushion:** The SLR acts as a cushion to ensure bank solvency and liquidity.
*   **Credit Growth:** A reduction in SLR frees up funds held in reserves, increasing a bank's capacity to lend. To utilize these surplus funds, banks may lower lending rates, which can stimulate credit growth in the economy.

**Distinction from CRR**
The SLR is distinct from the Cash Reserve Ratio (CRR). While SLR can be held in various liquid assets, the CRR must be maintained specifically in cash with the Reserve Bank of India (RBI).

**Role as a Policy Tool**
The RBI uses SLR, along with other tools like the CRR and repo rate, to manage liquidity, control interest rates, and regulate credit availability. Changes in SLR do not directly influence foreign investment flows or cause dramatic short-term shifts in economic growth.

IASCODEX · Answer

Option A: India's GDP growth rate increases drastically

IASCODEX · Answer

Option B: Foreign Institutional Investors may bring more capital into our country

IASCODEX · Answer

Option D: It may drastically reduce the liquidity to the banking system