Liquidity Adjustment Facility (LAF)
Liquidity Adjustment Facility
Liquidity Adjustment Facility is the primary instrument of Reserve Bank of IndiaThe Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934 with ..... for modulating liquidity and transmitting interest rate signals to the market.
- The Committee for Banking Sector Reforms (Narsimham committee -II) , 1998 recommended that the RBI’s support to the market should be through a Liquidity Adjustment Facility (LAF) operated by way of repo and reverse repoReverse repo rate is the rate of interest at which the RBI borrows funds from other banks in the short term. This is done by ..... providing a reasonable corridor to market playersA diverse range of intermediaries and institutional investors active in the capital market. This includes securities firms, broker dealers, commercial banks, merchant banks, unit trust/mutual ......
- An interim LAF was introduced in 1999 to provide a ceiling and the fixed rate repos were continued to provide a floorTrading hall of the Stock Exchange where transactions in securities take place. The trading ring where members and their assistants assemble with their order books ..... for money marketThe market encompassing the trading and issuance of short-term non-equity debt instruments, including treasury bills, commercial paper, bankers’ acceptance, certificates of deposits etc. The market ..... rates.
- Liquidity Adjustment Facility was introduced for the first time from June 2000 onwards. Subsequent revisions were made in 2001 and 2004.
Under the scheme, repo auctions (for absorption of liquidity) and reverse repo auctions (for injection of liquidity) are conducted on a daily basisIn a futures market, basis is defined as the cash price (or spot price) of whatever is being traded minus its futures price for the ..... (except Saturdays). It is same-day transactions, with interest ratesWhen a person borrows some money from another person, this money comes at an interest which can also be called the "Opportunity Cost" of the ..... decided on a cut-off basis and derived from auctions on a uniform price basis.
Objective
The objective of the Liquidity adjustment facility (LAF) is to aid banks in adjusting the day to day mismatches in liquidity.The two components of LAF are repo rateRepo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This is done by RBI buying government bonds ..... and reverse repo rate. Under Repo, the banks borrow money from Reserve bank of India In 1926, the Royal Commission on Indian Currency and Finance which is also known as the Hilton-Young Commission recommended the creation of a central bank. ..... to meet short term needs by selling securities to RBI with an agreement to repurchase the same at predetermined rate and date. Since Banks can sell securities to RBI, Repo thus injects liquidity into the system. Under Reverse repo, RBI borrows money from banks by lending securities. Thus Reverse repo absorbs the liquidity from the system. Please note that ONLY Government securities are used for collateral under LAF as of now. Oil bonds have been also suggested to be included as collateral for Liquidity adjustment facility recently.
Please note that from May 2011 onwards, only repo rate is announced and Reverse Rate is linked to it. Reverse repo rate is 100 basis points below repo rate.
Marginal Standing Facility
Further, Marginal Standing Facility is a new window created by Reserve Bank of India in its credit policy released in the first week of May 2011. The objective of Marginal Standing Facility is to "contain volatilityVolatility equates to the variability of returns from an investment. It is an acceptable substitute for risk; the greater the volatility, the greater is the ..... in the overnight inter-bank rates". The rate of interest on this facility is above 100 bps above the Repo Rate. The banks can borrow up to 1 percent of their net demand and time liabilitiesAny claim for money against the assets of a company, such as bills of creditors, income tax payable, debenture redemption, interest on secured and unsecured ..... (NDTL) from this facility. This means that Difference between Repo Rate and MSF is 200 Basis Points. So, Repo rate will be in the middle, the Reverse Repo Rate will be 100 basis points below it, and the MSF rate 100 bps above it.
