CH 2: BANKING REGULATION – RBI – PART 3

Liquidity Adjustment Facility

A liquidity adjustment facility (LAF) is a tool used in monetary policy that allows banks to borrow money through repurchase agreements. It is a short term credit control measure. All banks and NBFC can avail LAF. Minimum Rs. 5 Crore. It has 2 instruments a) Repo Rate b) Reverse Repor Rate

repo rate
Liquidity Adjustment Facility

 

Repo Rate (RR)

Also known as RBI Policy rate. It is the rate at which commercial banks borrow from RBI by keeping goverment securities as colleteral. This govt securities cannot be from SLR.

If the Repo rate is increased:

Banks borrow from RBI at higher interest rates => Banks charges higher interest rates to borrowers => customer borrow less => money supply will come down => inflation is controlled.

Reverse Repo Rate

It is the rate at which RBI borrows from commercial banks by mortgaging its dated Govt Securities and T Bills. If Reverse repo has been increased, banks are happy to park their money with RBI, the ultimate safe hands. Hence money supply into the economy is controlled.

Marginal Standing Facility (MSF)

Marginal Standing Facility is meant for providing liquidity support to banks. Under the facility, all Scheduled Commercial Banks having Current Account and SGL Account with RBI can avail overnight. Minimum Rs 1 Crore. SLR Securities can be used as securities. Max Limit 1% of NDTL. Rural banks can’t avail MSF facility.

Market Stabilisation Scheme (MSS)

Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity by selling government securities in the economy. MSS is used when there is high liquidity in the system. The money obtained under MSS should be kept with the RBI. It should not be transferred to the government.

Let Us Sum Up

  • Repo and Reverse Repo rates are 2 instruments of LAF to control credit in the economy.
  • RBI lends money to banks at REPO rate.
  • RBI borrows money from banks at Reverse Repo rate.
  • Marginal Standing Facility provide liquidity support to banks.
  • MSS is used mainly to reduce liquidity in economy.

References:

  • “Principles & Practices of Banking”, Tata McGraw-Hill, New Delhi.
  • My Virtual Guru – http://www.mrunal.org
  • “Indian Economy “, Sankarganesh Karuppiah, Kavin Mukul Publications.

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