Why banks are buying more G-Secs than they need

Commercial banks are mandatorily required to maintain a Statutory Liquidity Ratio (SLR), which currently stands at 18%. Therefore, banks are required to invest a minimum of 18% of their net demand and fixed liabilities in government securities and other approved securities.

In fact, deposits held by commercial banks are a good proxy for their demand and fixed liabilities. As of September, 29.8% of banks’ deposits were in government securities and other approved securities.

In fact, over the years, commercial banks have held significantly more government securities and other accepted securities than they have been mandated for. However, this was not always the case.

Take a look at the attached chart. The Reserve Bank of India (RBI) has been cutting SLR for years. This has come down from 25% in January 2010 to 18% currently. At the same time, the proportion of bank deposits invested in government securities and other accepted securities is largely around 30%. The point is that banks have not invested less money in mandated government securities and other approved securities since 2010 with the reduction in SLR.

Before we get into the reasons for this, a short look at the history of the SLR is important. In December 1964, banks were to maintain an SLR of 25%. The proportion of deposits invested in mandatory government securities and other approved securities stood at 30.3%. The SLR remained at 25% till January 1970.

In the times to come, the SLR continued to reach a high of 38.5% in September 1990, which lasted till December 1992. Interestingly, when the SLR was 38.5% in December 1992, commercial banks had invested 39.7% of it. Their deposits in Government and other approved securities. The point is that the gap between what was mandated and what was achieved was not much.

The SLR has been on a downward trend since January 1993, when it was first reduced to 38.25 per cent. This was reduced to 25% by October 1997. It stood at 25% in November 2010, when a new round of SLR reduction began. In November 2010, the proportion of deposits invested in government and other approved securities stood at 30.6%. Again, the difference between what was imperative and what was achieved was not much.

However, the gap between what is mandated and what is achieved has widened in recent years. There could possibly be three reasons for this. The first is lazy banking. Banks find it easier to invest in government securities and earn a good rate of return. The second is that there are not enough loan-worthy potential borrowers to whom the money can be lent. Hence, from a point forward, it makes sense for banks to invest in government securities.

Third, over the past decade, banks have accumulated huge amounts of bad loans, which peaked in March 2018. 10.36 trillion. Bad loans are mainly loans that have not been repaid for 90 days or more. Since banks have been unable to recover a major portion of these bad loans, they are simply reluctant to lend beyond a point and, therefore, stop buying government securities. The problem is that it also has side effects. With less money available to non-government borrowers, they pay higher interest rates on the loans taken by them.