Liquidity Adjustment Facility (LAF)
Liquidity Adjustment Facility (LAF) is the primary instrument of Reserve Bank of India for modulating liquidity and transmitting interest rate signals to the market. It refers to the difference between the two key rates viz. repo rate and reverse repo rate. Informally, Liquidity Adjustment Facility is also known as Liquidity Corridor.
When LAF was introduced?
On the basis of recommendations of second Narsimham Committee, 1998, an interim LAF was introduced in 1999 to provide a ceiling and the fixed rate repos were continued to provide a floor for money market rates. Liquidity Adjustment Facility was introduced for the first time from June 2000 onwards. Subsequent revisions were made in 2001 and 2004. The committee had recommended that RBI’s support to the market should be through a Liquidity Adjustment Facility (LAF) operated by way of repo and reverse repo providing a reasonable corridor to market players.
How Liquidity Adjustment Facility works?
As mentioned above, the two components of LAF are repo rate and reverse repo rate. Under Repo, the banks borrow money from RBI to meet short term needs by putting government securities (G-secs) as collateral. Under Reverse Repo, RBI borrows money from banks by lending securities. While repo injects liquidity into the system, the Reverse repo absorbs the liquidity from the system. RBI only announces Repo Rate. The Reverse Repo Rate is linked to Repo Rate and is 100 basis points (1%) below repo rate. RBI makes decision regarding Repo Rate on the basis of prevalent market conditions and relevant factors.
When the Repo and Reverse Repo Auctions done?
RBI conducts the Repo auctions and Reverse Repo auctions on daily basis from Monday to Friday except holidays. The tenure of the Repo is seven working days.
Which banks participate in LAF auctions?
All the Scheduled Commercial Banks are eligible to participate in auctions except the Regional Rural Banks. Further, the Primary Dealers (PDs) having Current Account and SGL Account (Subsidiary General Ledger Account ) with Reserve Bank, Mumbai are also eligible to participate in the Repo and Reverse Repo auctions.
What are the bid sizes?
Under the Liquidity Adjustment Facility, bids need to be for a minimum amount of Rs.5 crore and in multiples of Rs. 5 Crore thereafter.
What kind of securities are auctioned?
ONLY Government of India dated Securities/Treasury Bills are used for collateral under LAF as of now.
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. You may read about it here.