August 10, 2014
Abstract: Reforming the current statutory liquidity ratio (SLR) regime is essential for stimulating the development of a vibrant government securities (G-Sec) market, which is crucial to the health of the overall financial market.
Although SLR is essentially a prudential mandate for banks, the policy of keeping it consistently at a relatively high level has made banks a significant source for government’s deficit financing. At the same time, SLR’s operational design has been customised to protect the banks’ profitability, by exempting the SLR bonds from mark-to-market requirements. Thus, the SLR mandate, in its current level and form, has impeded the G-Sec market severely by: (a) discouraging banks to actively trade their SLR portfolios; and (b) hampering efficient price discovery of G-secs. Clearly, carrying out reforms in the SLR framework can help achieve both market development and prudence objectives. Aggressive and timebound reforms have been suggested.
Keywords: SLR; banks; fiscal deficit; prudence objective; government security market; financial market; reforms; market development