Why is a Higher SLR Better Than a High REPO Rate?

“The ultimate purpose of monetary policy is to understand and promote the enhancement of the well-being of commoners.”

While global growth remains muted this financial year, overall economic activity in the Indian context has been encouraging. The RBI's decision to keep the repo rate unchanged at 6.50% is in line with the inflationary trends that have been visible so far. Increasing incremental CRR absorbs the surplus liquidity for managing the liquidity overhang.

Both initiatives impact credit deployment. Banks shall divert liquidity to RBI to meet higher SLR, leaving little to lend. On the other hand, higher Repo rates discourage borrowings due to higher costs. The EMIs go up, pushing pressure on individual pockets. The SLR hike penalises the banks, spares the borrowers, and is better for the masses.

The regulator does not pay any interest to banks on SLR. The RBI's increase in SLR and maintaining Repo rates is a win-win for RBI in

terms of the perception that interest rates have been retained untouched and in terms of liquidity through the SLR hike.

The imposition of Incremental CRR (ICRR) of 10% on NDTL (from May 19 to July 28 ) implies a liquidity depletion of ?1.15 tn/ ?996 billion. The

step assumes an effective CRR of 14.5% for the period concerned (4.5%+10%). Overall, this would lead to interest loss for banks, as banks were parking the short-term liquidity into STPL (short-term personal loans) and money markets instead of parking with RBI, which helped in some softening of CP/CD rates.

The immediate impact of RBI absorbing liquidity is hardening money market rates for big borrowers, including NBFCs/corporates. At the same time, banks will slightly impact their NIMs by 3-4 bps.

Some PSU banks benefitted more than others from the liquidity glut due to Rs2,000 notes withdrawal, while others toiled to get deposits by increasing rates. However, all the banks will have to maintain ICRR and thus construed as unfair to some banks who did not benefit much from the ?2,000 notes withdrawal.

In the context of macroeconomic policy, the Statutory Liquidity Ratio and the Repo Rate are tools central banks use to manage and influence the economy, particularly the money supply, inflation, and economic growth.

The SLR requires banks to maintain a certain percentage of their deposits in the form of liquid assets, such as cash, gold, or government securities. By increasing the SLR, the central bank reduces the funds banks can lend or invest in riskier assets, which can help control excessive credit growth and speculation.

Advantages of a Higher SLR: 1. Stability and Prudence: A higher SLR can promote financial stability by ensuring that banks hold sufficient highly liquid assets to meet depositor withdrawals and other short-term obligations.

2. Reduced Risk of Bank Runs: A higher SLR can help prevent bank runs by maintaining a larger buffer of liquid assets, enhancing depositor confidence.

3. Control over Credit Expansion: Increasing the SLR can help control excessive credit expansion and speculative bubbles, leading to financial instability.

Disadvantages of a Higher SLR: 1. Liquidity Squeeze: Too high an SLR could reduce the availability of credit in the economy, which might hinder investment and economic growth.

2. Interest Rates: If banks hold a more significant portion of their funds in low-yielding assets like government securities, it impacts their ability to offer competitive interest rates on deposits and loans.

The Repo Rate is when the central bank lends money to commercial banks for short periods, typically overnight. Changes in the Repo Rate can influence the cost of borrowing for banks and, consequently, affect interest rates throughout the economy.

Advantages of High Repo Rates: 1. Inflation Control: Increasing the Repo Rate can help reduce inflation by making borrowing more expensive, leading to lower consumer spending and investment.

2. Currency Value: Higher Repo Rates attract foreign capital seeking higher returns, leading to an appreciation of the domestic currency.

Disadvantages of High Repo Rates: 1. Economic Growth: High Repo Rates can dampen economic activity by making borrowing more expensive for businesses and individuals, potentially leading to slower economic growth.

2. Investment and Consumption: Higher borrowing costs discourage investment and consumption.

In comparing a higher SLR to high Repo Rates, the effectiveness of both depends on the goals of the RBI and the overall economic conditions. Central banks carefully consider the potential trade-offs and economic impacts.RBI has diligently sucked the liquidity to control inflation without increasing interest rates, which is a better option in existing economic conditions.

Rightly said, “Domestic inflation reflects domestic monetary policy."