Liquidity ratio is the proportion of assets of bank recognized as “liquid” by the central bank to its total assets. The proportion can be prescribed and revised at the discretion of the central bank within a prescribed range.
This instrument can be used for indirectly forcing the banking system to invest in certain types of financial assets such as the government securities. The central bank has the authority to revise the list of “liquid” assets from time to time subject to the expectation that some assets like “cash” and “government securities” will always form part of the list.
However, an important use of liquidity ratio is that the central bank can counteract some moves of the banking system to restructure its asset portfolio, which is not in conformity with the official priorities.