UPSC Prelims 2015 Q22: Indian Economy – Monetary Policy & Money Supply
When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points,
which of the following is likely to happen?
- (a) India’s GDP growth rate increases drastically
- (b) Foreign Institutional Investors may bring more capital into our country
- (c) Scheduled Commercial Banks may cut their lending rates
- (d) It may drastically reduce the liquidity to the banking system
Answer: (c) Scheduled Commercial Banks may cut their lending rates
Explanation
Reduction in the Statutory Liquidity Ratio (SLR)
SLR is the share of deposits that banks must keep in Government securities, gold or cash.
It is set under Section 24 of the Banking Regulation Act, 1949.
| When SLR is cut by 50 basis points | Result |
|---|---|
| Banks | Have more funds free to lend |
| Credit | Supply of loans rises |
| Lending rates | Banks may cut them |
The options checked:
| Option | Verdict |
|---|---|
| (a) India's GDP growth rate increases drastically | Incorrect; 'drastically' is too strong |
| (b) Foreign Institutional Investors may bring more capital | Incorrect; no direct link |
| (c) Scheduled Commercial Banks may cut their lending rates | Correct |
| (d) It may drastically reduce the liquidity to the banking system | Incorrect; it increases liquidity |
Answer: (c) Scheduled Commercial Banks may cut their lending rates.
Why each option is right or wrong
- (a) Incorrect. A small SLR cut cannot raise GDP growth drastically.
- (b) Incorrect. Foreign Institutional Investors respond to returns and risk, not to SLR.
- (c) CORRECT. With more lendable funds, Scheduled Commercial Banks may cut lending rates.
- (d) Incorrect. Cutting SLR adds liquidity to the banking system; it does not reduce it.
Key point
SLR (Section 24, Banking Regulation Act): share of deposits held in Government securities, gold or cash; a cut frees funds and may lower lending rates.
Remember
SLR cut: more lendable funds, rates may fall.
Common mistakes
- Confusing SLR (kept by the bank itself) with CRR (kept with the RBI).
- Thinking a cut in SLR reduces liquidity.
- Falling for 'drastically' in the options.
Exam tip
Lower SLR or CRR = more money to lend = lower rates (possibly). Look for the word 'may'.
Sources
- Reserve Bank of India — Master Direction on Cash Reserve Ratio and Statutory Liquidity Ratio
- Banking Regulation Act, 1949 — Section 24