UPSC Prelims 2010 Q16: Indian Economy – Monetary Policy & Money Supply
Which of the following terms indicates a mechanism used by commercial banks for
providing credit to the government ?
- (a) Cash Credit Ratio
- (b) Debt Service Obligation
- (c) Liquidity Adjustment Facility
- (d) Statutory Liquidity Ratio
Answer: (d) Statutory Liquidity Ratio
Explanation
Which mechanism lets banks lend credit to the government
Indian banking regulation requires commercial banks to hold a portion of assets in government securities.
| Option | Verdict | Reason |
|---|---|---|
| (a) Cash Credit Ratio | Incorrect | This is not a standard recognized term; the real reserve requirement is CRR (Cash Reserve Ratio), which isn't about government credit specifically |
| (b) Debt Service Obligation | Incorrect | This term relates to a borrower's debt repayment burden, not a bank-to-government credit mechanism |
| (c) Liquidity Adjustment Facility | Incorrect | LAF is RBI's tool for short-term liquidity management with banks, not specifically a credit-to-government mechanism |
| (d) Statutory Liquidity Ratio | Correct | Under SLR, banks must hold a prescribed percentage of their net demand and time liabilities in government securities/approved assets, effectively channeling credit to the government |
SLR basics:
| Point | Detail |
|---|---|
| Requirement | Hold a % of NDTL in government securities/approved assets |
| Effect | Ensures banks fund government borrowing |
| Regulator | Reserve Bank of India |
Answer: (d) Statutory Liquidity Ratio.
Why each option is right or wrong
- (a) Incorrect. 'Cash Credit Ratio' is not a standard RBI policy term for this mechanism.
- (b) Incorrect. Debt Service Obligation describes a borrower's repayment burden, not a bank-government credit channel.
- (c) Incorrect. Liquidity Adjustment Facility manages short-term bank liquidity, not specifically government credit provision.
- (d) CORRECT. The Statutory Liquidity Ratio requires banks to hold government securities, effectively providing credit to the government.
Key point
The Statutory Liquidity Ratio (SLR) requires banks to invest a portion of their liabilities in government securities, making it the mechanism through which commercial banks provide credit to the government.
Remember
Statutory Liquidity Ratio (SLR): the mechanism requiring banks to hold government securities, channeling credit to the government.
Common mistakes
- Confusing SLR with CRR (Cash Reserve Ratio) or the Liquidity Adjustment Facility, which serve different regulatory purposes.
- Not knowing SLR's specific requirement to hold government securities.
- Mistaking a made-up term like 'Cash Credit Ratio' for an actual RBI policy tool.
Exam tip
SLR = banks hold government securities = credit channel to the government. Don't confuse with CRR (cash with RBI) or LAF (liquidity management).
Sources
- Banking Regulation Act, 1949, Section 24 (Statutory Liquidity Ratio)
- Reserve Bank of India — Master Circular on Statutory Pre-emptions: CRR and SLR