Liquidity adjustment facility is a monetary policy tool used by RBI , which allows banks to borrow money through repurchase agreement with RBI. LAF is used to aid banks in adjusting the day to day mismatches in liquidity.
Liquidity adjustment facilities are used to aid banks in resolving any short term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control.
In 1998, Narsimham Committee on Banking Sector Reforms, recommends LAF.
In 1999, RBI introduces interim LAF
In 2000, RBI implemented full fledged LAF.
On recommendations of an RBI's Internal Group RBI has revised the LAF scheme on March 25,2004. further revision has been carried with effect from Oct 29,2004.
Two tools used under LAF
1. Repo Rate
2. Reverse Repo Rate
2. Reverse Repo Rate : Reverse repo is the exact opposite of repo. In a reverse repo transaction, banks purchase government securities form RBI and lend money to the banking regulator, thus earning interest. Reverse repo rate is the rate at which RBI borrows money from banks. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest.
It absorbs liquidity from the market.
Difference between Repo and Reverse Repo is called Corridor and it is generally 100 basis points or 1 percent.
Why Repo Rate is always kept higher than Reverse Repo ?
Like any other bank, RBI also has to keep some spread or gap or profit margin.
RBI cannot give more interest on deposit and charge lesser interest on loans
Thus, Repo rate is always higher than the Reverse repo rate.
Whenever, RBI requires tight monetary policy or contracts money supply in the economy it increase the Repo rate.
Whenever, RBI requires eased monetary policy or expands money supply in the economy, it decreases Repo rate.
Liquidity adjustment facilities are used to aid banks in resolving any short term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control.
In 1998, Narsimham Committee on Banking Sector Reforms, recommends LAF.
In 1999, RBI introduces interim LAF
In 2000, RBI implemented full fledged LAF.
On recommendations of an RBI's Internal Group RBI has revised the LAF scheme on March 25,2004. further revision has been carried with effect from Oct 29,2004.
Two tools used under LAF
1. Repo Rate
2. Reverse Repo Rate
1. Repo Rate: Repo means Repurchase Offer or Sale & Repurchase Agreement.It is a collaterised lending.Under this, Bank borrows money from RBI to meet their short term needs by selling securities to RBI with an agreement to repurchase the same in future.The rate charged by RBI for this transaction is called Repo Rate. It injects liquidity in the market.
It absorbs liquidity from the market.
Difference between Repo and Reverse Repo is called Corridor and it is generally 100 basis points or 1 percent.
Why Repo Rate is always kept higher than Reverse Repo ?
Like any other bank, RBI also has to keep some spread or gap or profit margin.
RBI cannot give more interest on deposit and charge lesser interest on loans
Thus, Repo rate is always higher than the Reverse repo rate.
Whenever, RBI requires tight monetary policy or contracts money supply in the economy it increase the Repo rate.
Whenever, RBI requires eased monetary policy or expands money supply in the economy, it decreases Repo rate.
Thank you sir.
ReplyDelete