The main objectives for maintaining the SLR (Statutory Liquidity
Ratio - mandated investments in government securities) ratio are the following:
** To control the expansion
of bank credit. By changing the level of SLR, the Reserve Bank of India (RBI)
can increase or decrease bank credit expansion.
** To ensure the solvency of
commercial banks.
** To compel the commercial banks to invest in government securities
like government bonds.
If any Indian bank fails to maintain the required level of SLR, then
it becomes liable to pay penalty to RBI. The defaulter bank pays penal interest
at the rate of 3 % per annum above the Bank Rate, on the shortfall amount for
that particular day.
But, according to the Circular, released by the Department of Banking
Operations and Development, RBI; if the defaulter bank continues to default on
the next working day, then the rate of penal interest can be increased to 5 %
per annum above the Bank Rate. This restriction is imposed by RBI on banks to
make funds available to customers on demand as soon as possible.
Gold and government securities (or gilts) are included along with
cash because they are highly liquid and safe assets.
The RBI can increase the SLR to contain inflation, suck liquidity in
the market, to tighten the measure to safeguard the customers money. In a
growing economy banks would like to invest in stock market, not in government
securities or / gold as the latter would yield less returns. One more reason is
long term government securities (or / any bond) are sensitive to interest rate
changes.
But in an emerging economy interest rate change is a common activity.
From Wikipedia
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