You are on page 1of 2

Marginal Standing Facility Rate : Under this scheme, Banks will be able to borrow upto 1% of their respective Net

Demand and Time Liabilities". The rate of interest on the amount accessed from this facility will be 100 basis points (i.e. 1%) above the repo rate. This scheme is likely to reduce volatility in the overnight rates and improve monetary transmission. In the policy statement RBI has also declared "The stance of monetary policy is, among other things, to manage liquidity to ensure that it remains broadly in balance, with neither a large surplus diluting monetary transmission nor a large deficit choking off fund flows."
unencumbered approved securities" of a banking company shall include its approved securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against or availed of.]

Liquidity adjustment facility (LAF) is a monetary policy tool which allows banks to borrow money through repurchase agreements. LAF is used to aid banks in adjusting the day to day mismatches in liquidity.LAF consists of repo and reverse repo operations. Repo or repurchase option is a collaterised lending i.e. banks borrow money from Reserve bank of India to meet short term needs by selling securities to RBI with an agreement to repurchase the same at predetermined rate and date. The rate charged by RBI for this transaction is called the repo rate. Repo operations therefore inject liquidity into the system. Reverse repo operation is when RBI borrows money from banks by lending securities. The interest rate paid by RBI is in this case is called the reverse repo rate. Reverse repo operation therefore absorbs the liquidity in the system. The collateral used for repo and reverse repo operations comprise of Government of India securities. Oil bonds have been also suggested to be included as collateral for Liquidity adjustment facility. Liquidity adjustment facility has emerged as the principal operating instrument for modulating short term liquidity in the economy. Repo rate has become the key policy rate which signals the monetary policy stance of the economy. The origin of repo rates, one of the component of liquidity adjustment facility, can be traced to as early as 1917 in U.S financial market when war time taxes made other sources of lending unattractive . The introduction of Liquidity adjustment facility in India was on the basis of the recommendations of Narsimham committee on banking sector reforms. In April 1999, an interim LAF was introduced to provide a ceiling and the fixed rate repos were continued to provide a floor for money market rates. As per the policy measures announced in 2000, the Liquidity Adjustment Facility was introduced with the first stage starting from June 2000 onwards. Subsequent revisions were made in 2001 and 2004. When the scheme was introduced, repo auctions were described for operations which absorbed liquidity from the system and reverse repo actions for operations which injected liquidity into the system. However in international nomenclature, repo and reverse repo implied the reverse. Hence in October 2004 when revised scheme of LAF was announced, the decision to follow the international usage of terms was adopted. Repo and reverse repo rates were announced separately till the monetary policy statement in 3.5.2011. In this monetary policy statement, it has been decided that the reverse repo rate would not be announced separately but will be linked to repo rate. The reverse repo rate will be 100 basis points below repo rate. The liquidity adjustment facility corridor, that is the excess of repo rate over reverse repo, has varied between 100 to 300 basis points. The period between April 2001 to March 2004 and June 2008 to early November 2008 saw a broader corridor ranging from 150-250 and 200-300 basis points respectively. During March 2004 to June 2008 the corridor was narrow with the rates ranging from 100-175 basis points. A narrow LAF corridor is reflected from November 2008 onwards. At present the width of the corridor is 100 basis points. This corridor is used to contain any volatility in short term interest rates.

Much like people often need collateral to borrow money from a bank, a bank needs to offer collateral to receive a liquidity adjustment facility loan. Unlike people, who use property or assets as collateral, banks can only use assets and financial securities, including the interest gained from accounts, bonds and other financial assets the bank owns. If the banksuccessfully repays its loan, then the collateral will be returned. When a liquidity adjustment facility and a bank enter a loan agreement, a repurchase agreement is written up. This agreement states the interest rate the bank has to pay back on this short-term loan and describes the securities the bank is putting up for the loan, so both the facility and bank know what securities are going back to the bank after the repurchase. The repurchase agreement also states how much more money the bank has to pay back in late payments if the repayments are not made on time.

You might also like