Rethinking SLR Through India’s Political Reality

Swaminathan Aiyar’s recent argument in The Economic Times for dismantling the Statutory Liquidity Ratio merits attention. He is correct that SLR can direct bank resources toward the sovereign, and correct again to caution that banks cannot be reduced to bond-placement arms of governments.

But the argument for simply abolishing the SLR lands away from India’s reality. It is one thing to ask governments to be fiscally disciplined. It is another to expect them to build revenue moats in a climate where welfarism drives electoral competition across states and nationally. A political ecosystem built on expanding welfare commitments has little incentive to become financially austere without countervailing institutional pressure.

There is another assumption in Mr Aiyar’s argument that suggests that Indian banks are stable, rational actors in all circumstances. Time and again the Reserve Bank of India has had to intervene in troubled banks and nudge others toward safer behaviour. The banking system is also expected to shoulder social-engineering responsibilities by lending to sectors that are not always commercially attractive yet vital for development. A system carrying both commercial and societal obligations cannot be left entirely to market impulses.

A further reality is that banks themselves often choose caution over expansion. Many prefer holding high-quality liquid assets beyond regulatory requirements rather than invest in stronger credit-delivery capabilities or widen risk appetites. Years of scrutiny, post-crisis caution and memories of supervisory action have created a culture where bankers would rather be conservative and retire peacefully than be hauled up years later for a credit decision taken in good faith. This behavioural hesitation reinforces the need for consistently sought political support for bankers.

Indian banking has also grown with a structural skew. Unlike other economies where large corporates rely on deep bond markets and banks specialise in broader non-corporate lending, India’s banks have long anchored themselves to corporate credit. Decades of this “lazy-banking” concentration have dulled competitive hunger and slowed the development of newer credit-underwriting capabilities.

There seems an unspoken wrong assumption that India Inc is brimming with animal spirits and that banks are eager to lend but held back only by statutory liquidity demands. Credit expansion today is constrained far less by SLR and far more by risk aversion, weak private capex appetite and structural caution ingrained across the system. Removing a buffer does not create confidence where it does not yet exist. 

So let us not criticise the RBI’s SLR for bank’ Slow Lending Resolve. The SLR is not an Indian invention, but part of a global regulatory instinct that requires banks to hold high-quality liquid assets. The Basel norms require banks worldwide to maintain a Liquidity Coverage Ratio to withstand sudden outflows. Regulators everywhere enforce reserve or liquidity mandates, apart from the Basel norms, because finance amplifies political choices and because banking systems are tested by fiscal events outside the regulator’s control.

That banks must hold part of their liabilities in government securities is a valid criticism. Yet the alternative cannot be a vacuum. India’s sovereign paper remains solid credit. Removing the SLR will expose banks to sovereign borrowing pressures in other forms. When governments must borrow, they will borrow. If one structured channel disappears, the political system will find an unstructured one. Banks will still support public borrowing but with fewer safety rails.

While many advanced-economy central banks have transferred debt management to treasury agencies, several emerging-market counterparts still retain that function. The RBI does so too, but unlike most, it carries this responsibility while also upholding a high standard of supervision, liquidity stewardship and monetary stability — a balancing act few central banks manage with comparable credibility.

The SLR can remain a steady anchor in a system where political and fiscal impulses often move faster than institutional safeguards. The real debate must shift to fiscal discipline in the states, whose widening welfare commitments and lack of long-term revenue-building create the very pressures that make liquidity buffers necessary. No financial regulator, however independent it may appear, can unilaterally discipline elected governments. The SLR thus becomes a pragmatic tool that offsets the structural gap between political incentives and economic prudence.

This risk aversion is not unique to banking. It mirrors the chorus in Mumbai’s real-estate circles where developers and political patrons demand that mangroves and salt-pan lands be opened for construction, forgetting that these natural buffers are the city’s last defence against the fury of the sea.

If one wishes to even entertain an idea like removing the SLR, the first reform must be to bring every banking institution under a single legal framework rather than the current patchwork of statutes for SBI, public-sector banks and others. Fragmented laws create fragmented governance, uneven supervision and inconsistent accountability. As long as banks operate under different Acts, the state might treat the ones it owns as extensions of itself rather than regulated entities bound by a unified corporate-governance discipline.

One must recognise that Indian capitalism is not the textbook variety that advanced economies assume. It is a negotiated blend of market ambition and socialist inheritance shaped within a noisy electoral democracy, and including unruly state finances.

The reality of our per capita GDP reminds us that we remain a lower-middle-income nation with millions still vulnerable to volatility. Our financial system cannot behave as if it were operating in a purely capitalist arena where depositors, consumers and small enterprises absorb the full force of market shocks. Financial stability needs buffers that must be engineered by designing protections that reflect the world as it is.