Marginal Standing Facility

The Marginal Standing Facility (MSF) is a monetary policy instrument introduced by the Reserve Bank of India (RBI) in May 2011. It enables scheduled commercial banks to borrow overnight funds from the central bank against approved government securities when the interbank liquidity is tight. The MSF serves as a safety valve for the banking system, providing an avenue for short-term liquidity support at a penal rate of interest above the repo rate. It is a crucial element of the RBI’s Liquidity Adjustment Facility (LAF) framework, aimed at ensuring financial stability and maintaining orderly conditions in the money market.

Background and Introduction

Before the MSF was established, banks facing liquidity shortages had to depend on the Liquidity Adjustment Facility (LAF), which included the repo and reverse repo operations. However, these operations had certain limits, and banks often resorted to borrowing from the interbank call money market at high rates when liquidity tightened. To reduce volatility in overnight rates and provide banks with an assured liquidity window even after exhausting their LAF quota, the Reserve Bank of India introduced the MSF during the 2011–12 monetary policy review.
Under this facility, banks can borrow up to a certain percentage of their Net Demand and Time Liabilities (NDTL), initially fixed at 1% and later revised to 2% and subsequently 3% as per liquidity conditions. The borrowing is collateralised by Statutory Liquidity Ratio (SLR) eligible securities, which are typically government bonds held by banks.

Objectives and Purpose

The MSF was designed with multiple objectives in mind:

• To provide emergency liquidity support to banks facing short-term mismatches.
• To stabilise overnight call money rates by reducing volatility in interbank borrowing costs.
• To act as a penal rate window, discouraging frequent reliance on central bank funding.
• To serve as an upper bound of the policy rate corridor, with the reverse repo rate forming the lower bound.

Thus, the MSF complements the repo and reverse repo facilities, forming a symmetrical corridor for short-term money market operations.

Operational Framework

Banks can access the Marginal Standing Facility after fully utilising their quota under the LAF repo window. The key operational features include:

• Eligibility: All scheduled commercial banks (excluding Regional Rural Banks) are eligible to borrow under MSF.
• Collateral: Borrowing must be backed by SLR-eligible securities that are in excess of the statutory minimum requirement.
• Tenure: The borrowing is typically overnight, though the RBI may modify the duration during periods of exceptional liquidity stress.
• Interest Rate: The MSF rate is set above the repo rate, usually by 25 basis points (bps). For example, if the repo rate is 6.50%, the MSF rate would be 6.75%.
• Quantum: Banks can borrow up to 3% of their NDTL, subject to RBI’s discretion.

The rate corridor defined by the reverse repo rate (floor) and the MSF rate (ceiling) helps the RBI guide short-term interest rates within a predictable range.

Role in Liquidity Management

The MSF plays an essential role in the RBI’s liquidity management framework. It provides banks with an additional avenue for funds when the interbank market is tight, thereby reducing panic borrowing and volatility. By setting the MSF rate marginally above the repo rate, the RBI ensures that banks first exhaust cheaper sources of liquidity before resorting to the MSF.
During times of financial stress, such as the COVID-19 pandemic in 2020, the RBI adjusted MSF limits and rates to inject liquidity into the banking system. In such cases, the central bank temporarily increased the MSF borrowing limit or reduced the spread between repo and MSF rates to facilitate easier access to funds.

Significance in Monetary Policy Transmission

The MSF has become a key signalling mechanism in India’s monetary policy transmission process. It sets a ceiling for overnight rates, while the reverse repo rate acts as a floor, and the repo rate serves as the operational target for the RBI. This corridor approach ensures that the weighted average call rate (WACR) — the operating target of monetary policy — remains within the band, enhancing policy effectiveness.
By providing a predictable framework for liquidity adjustment, the MSF contributes to smoother interest rate transmission across money and credit markets. It also reflects the RBI’s stance on liquidity — a higher spread between the repo and MSF rates indicates a tighter policy, while a narrower spread signals an accommodative stance.

Comparison with Repo and Reverse Repo

The MSF differs from other key RBI facilities in several respects:

This triangular relationship forms the policy rate corridor, guiding the movement of short-term market interest rates.

Advantages and Limitations

Advantages:

• Provides a safety mechanism for banks during unexpected liquidity shortfalls.
• Stabilises overnight call money rates.
• Enhances monetary policy transmission and predictability.
• Helps avoid extreme volatility in interbank borrowing costs.

Limitations:

• Penal rate discourages frequent usage.
• Overreliance may signal poor liquidity management within banks.
• Effectiveness depends on the availability of eligible collateral.