Liquidity Adjustment facility(LAF)

A liquidity adjustment facility (LAF) is a monetary policy instrument primarily employed by the Reserve Bank of India (RBI) that allows banks to borrow money through repos or make loans to the RBI through reverse repo agreements. This structure aids in decreasing liquidity needs and guaranteeing the basic stability of the financial markets. Let us look at the meaning, genesis, and goals of LAF in this post.

What is Liquidity Adjustment Facility?

• It is a monetary policy instrument primarily utilised by the Reserve Bank of India (RBI) to regulate the economy's liquidity or money supply.
• It does this by letting banks to borrow money through repurchase agreements (repos) or lend money to the RBI through reverse repo arrangements.
• The Narasimhan Committee on Banking Reforms advocated the Liquidity Adjustment Facility, which was implemented by the RBI in 1998.
• The Liquidity Adjustment Facility (LAF) is made up of two major components:

1. RERO RATE: The repo rate is the interest rate at which the Reserve Bank of India (RBI) loans to other banks

2. REVERSE REPO RATE: The Reserve Bank of India (RBI) borrows from commercial banks at the reverse repo rate.

Objectives of Liquidity Adjustment Facility

• It minimises liquidity requirements while ensuring financial market stability.
• It enables banks to employ repurchase agreements, or repos, to address short-term liquidity shortages.

Marginal Standing Facility

MSF, or Marginal Standing Facility, allows banks to borrow cash from the RBI (Reserve Bank of India) in times of emergency when their liquidity is completely depleted. This short-term borrowing plan enables scheduled banks to get funds from the Reserve Bank of India (RBI) overnight in the event of a severe cash shortfall by providing their certified government assets. Banks frequently encounter liquidity shortages as a result of the financial gap generated by a mismatch between their deposit and lending portfolios. Such deficiencies do not endure long, and banks can contact the RBI for rapid money for a period of one day within the constraints of the Statutory Liquidity Ratio (SLR).

When and Why MSF was introduced?

MSF was implemented by the Reserve Bank of India in its 2011-12 Monetary Policy. However, it went into effect on May 9, 2011. This facility was originally introduced in June 2011 after its inception, and banks borrowed Rs.1 billion under this policy in its first year.

This most recent liquidity adjustment facility was implemented to improve the stability of overnight lending rates between banks, hence supporting appropriate financial transmission in the banking system. It aided the RBI in gaining better control over the supply of money in India's financial system.

How does MSF Work?

When commercial banks are in desperate need of cash, they commit to the RBI that they would supply funds at a greater rate than the repo rate under the LAF, or Liquidity Adjustment Facility. The MSF rate is typically 0.25 percent, or 25 basis points higher than the repo rate. Using this tool, all scheduled banks under the RBI can get funds in an emergency up to 1% of their NDTL (net demand and time liabilities) or SLR securities. This extraordinary facility can only be committed by banks in an emergency situation when interbank liquidity has fully frozen.

What is MSF Rate?

The MSF rate, also known as the Marginal Standing Facility rate, is the interest rate at which the Reserve Bank of India lends money to scheduled commercial banks that are experiencing a severe liquidity shortfall. This rate is not the same as the repo rate, and banks can get overnight cash from the RBI by paying the special MSF rate. To keep the Indian economy stable, the RBI can change the rate of borrowing and the percentage of borrowing under MSF. The MSF rate, also known as the Marginal Standing Facility rate, is the interest rate at which the Reserve Bank of India lends money to scheduled commercial banks that are experiencing a severe liquidity shortfall. This rate is not the same as the repo rate, and banks can get overnight cash from the RBI by paying the special MSF rate. To keep the Indian economy stable, the RBI can change the rate of borrowing and the percentage of borrowing under MSF.

MSF's interest rate was 100 basis points higher than the Repo rate when it was introduced in May 2011, and by paying this rate, banks may receive up to 1% of their net demand and time liabilities (NDTL), which refers to their total deposits and obligations connected to borrowings from other banks. However, in July 2013, the RBI hiked the MSF rate to 300 (3%) basis points higher than the Repo rate in order to control the rupee's decreasing value. Later, in another change, the central bank cut it to 50 basis points, making it simpler for banks to receive money from the RBI whenever they needed it right away. According to the most recent change to the RBI's monetary policy, which was made on October 4, 2017, the MSF rate is set at 6.25 percent, which is 25 basis points higher than the current Repo rate.

As a result, the MSF rate has changed multiple times since its inception, as the RBI cuts or increases the rate of MSF to maintain a balance in the country's economic state.

What is the Current MSF Rate?

The MSF borrowing rate is now 6.25 percent per year, which is 25 basis points or 0.25 percent more than the Repo rate. In layman's words, scheduled commercial banks can now obtain funds from the RBI by selling government securities at an interest rate of 6.25 percent per year when they are no longer eligible to receive funds at the repo rate of 6 percent per annum.