Why in news
- Financial market analysts recommended widening the Reserve Bank of India's Liquidity Adjustment Facility (LAF) corridor to absorb systemic liquidity shocks.
Key terms
Liquidity Adjustment Facility
RBI framework allowing banks to manage short-term liquidity through Repo and reverse repo/SDF mechanisms.
Standing Deposit Facility
Collateral-free liquidity absorption facility positioned as the floor of the LAF corridor.
Marginal Standing Facility
Penal borrowing window for scheduled commercial banks to borrow overnight funds against excess SLR.
Weighted Average Call Rate
The operating target of RBI monetary policy reflecting uncollateralised overnight interbank lending rates.
What is the Liquidity Adjustment Facility (LAF)?
- LAF is a primary monetary policy tool used by the RBI to allow banks to borrow money through repurchase agreements (repos) or lend to the RBI through reverse repos/SDF.
- It assists commercial banks in managing day-to-day liquidity mismatches and ensures stability in overnight call money rates.
Structure of the LAF Corridor
- The upper bound of the corridor is formed by the Marginal Standing Facility (MSF) rate, where banks borrow emergency funds against SLR securities.
- The lower bound is defined by the Standing Deposit Facility (SDF) rate, allowing banks to deposit uncollateralised surplus liquidity with the RBI.
- The Repo Rate acts as the central policy signaling rate within this operating corridor.
Why Corridor Adjustment Matters
- An asymmetric or widened corridor provides the central bank greater flexibility to steer weighted average call rates without frequent formal policy rate adjustments.
- Helps anchor short-term money market expectations during heightened global financial and currency market volatility.
Prelims facts
- SDF allows liquidity absorption without requiring the RBI to provide collateral government securities.
- MSF rate is pegged above the policy Repo rate, while SDF is pegged below it.
Mains discussion
- Evaluates the efficacy of monetary policy transmission and overnight rate stability under external economic shocks.
Source: Business Standard
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