Liquidity Adjustment Facility (LAF) | Marginal Standing Facility (MSF)

In this article, we will discuss about:

• Liquidity Adjustment Facility (LAF) - Repo Rate and Reverse Repo Rate,
• Marginal Standing Facility (MSF),
• Differences between Repo Rate and MSF

Liquidity Adjustment Facility (LAF)

The liquidity requirements of a bank varies on a daily basis. On one day, more number of customers can come to bank to withdraw their money while on the other day, more number of depositors can come to bank to deposit the money. Thus, net demand and time liabilities (NDTL) of bank fluctuates regularly.

Liquidity Adjustment Facility or LAF helps bank to meet their fluctuating daily liquidity requirements through two instruments:

a) Repo Rate

b) Reverse Repo Rate

i) REPO RATE

The interest rate at which commercial banks can borrow money from the central bank (Reserve Bank of India) to meet their short-term liquidity needs by selling the government securities to RBI and signing a repurchase agreement with the RBI to repurchase the same government securities kept as collateral on a particular date at a particular price is called Repo Rate.

The government securities kept as collateral should not be from the quota of Statutory Liquidity Ratio (SLR.)

Repo rate is considered as the POLICY RATE.

ii) REVERSE REPO RATE

When commercial banks are flooded with funds, they park the extra funds with RBI and in turn RBI provides them interest rate called as REVERSE REPO RATE. Thus, Reverse Repo Rate is the interest rate paid by the RBI to the commercial banks for keeping their funds with RBI.

Usually, Reverse Repo Rate is kept lower than Repo Rate.

Marginal Standing Facility (MSF)

Marginal Standing Facility or MSF is the interest rate at which scheduled banks can borrow from the central bank (RBI) by keeping government securities as collateral (not selling and repurchase).

MSF is additional facility provided to the scheduled commercial banks over and above what is available under LAF for managing liquidity requirements.

Thus, Marginal Standing Facility is kept higher than Repo rate which is a part of Liquidity Adjustment Facility (LAF).

Marginal Standing Facility helps to reduce volatility in overnight lending rates in inter-bank market and is used by the banks in emergency situations when inter-bank liquidity dries up completely.

MSF can use the Statutory Liquidity Ratio (SLR) quota government securities as collateral to borrow money from RBI.

What are the differences between Repo Rate and Marginal Standing Facility (MSF)?

The four important differences between Repo Rate and Marginal Standing Facility (MSF) are:

1)  Repo Rate is available to the commercial banks while MSF is available to the scheduled banks.

2) Repo Rate is used by the commercial banks to meet their short-term liquidity needs whereas MSF is used by the scheduled banks to meet their overnight liquidity requirements.

3) The government securities kept as collateral cannot be from SLR quota for Repo Rate whereas for MSF, SLR quota government securities can be used as collateral.

4) For Repo Rate, the government securities are sold off and repurchased at a later date as per Repurchase Agreement whereas for MSF, the government securities are not sold off and are only kept as collateral.

Repo Rate	Marginal Standing Facility
Available to commercial banks	Available to scheduled banks
Used to meet short-term liquidity needs	Used to meet overnight liquidity requirements
Government securities kept as collateral CANNOT be from SLR quota	Government securities kept as collateral CAN be from SLR quota
Government securities and sold and repurchased later on	Government securities are not sold and only kept as collateral

Further Readings:

• 4 Monetary Policy Tools of RBI used to combat inflation and deflation - CRR, SLR, Repo Rate and Reverse Repo Rate