Liquidity Adjustment Facility

Liquidity Adjustment Facility or LAF is a facility extended by the Reserve Bank of India to the scheduled commercial banks (excluding RRBs) and Primary Dealers (PDs) to meet their mismatches in daily liquidity.

It is an important monetary policy instrument which helps the RBI to manage liquidity and provide economic stability by offering banks the opportunity to borrow money through repurchase agreements or repos or to make loans to the RBI via reverse repo agreements.

Various tools under the LAF including the popular repo and reverse repo are used by the RBI to manage liquidity in the financial system.

COMPONENTS OF LAF

There are two major components of liquidity adjustment facility –

REPO RATE – When banks need liquidity to meet its daily requirement, they borrow from RBI through repo. The rate at which they borrow fund is called the repo rate.

REVERSE REPO RATE –  The rate at which the RBI borrows money from the commercial banks against government approved securities is called a reverse repo rate. Through reverse repo operations, the liquidity is absorbed from the economy or the financial system.

On the liquidity management front, the LAF, is also supported by other instruments such as the CRR (Cash Reserve Ratio), OMO (Open Market Operations) and MSS (Market Stabilization Scheme).

IMPORTANCE OF LAF

The liquidity adjustment facility is used to aide banks in the emergency arising out of severe cash shortage or acute liquidity crisis. It is used for modulating the short-term liquidity and transmitting the interest rate into the market.

LAF’s can manage inflation in the economy by increasing and reducing the money supply.

WORKING OF LIQUIDITY ADJUSTMENT FACILITY

Liquidity adjustment facility has emerged as the principal operating instrument for modulating short term liquidity in the economy. It is used to inject liquidity in the economy during the time of shortages through Repo rate operations. Similarly, it absorbs liquidity from the economy when there is excess liquidity through Reverse Repo Rate operations.

The reverse repo rate is fixed lower than the repo rate. This means whenever the repo rate changes, the reverse repo rate also changes equally.

 

Thus, in simple words  the Liquidity Adjustment Facility or LAF is the principal operating monetary policy tool that allows banks to borrow money through repurchase agreements.

Accounting & Finance for Banking

Principles & Practices of Banking Module E Pdf

Free
Module E PPB ePDFs available in our android app. Get them all at https://iibf.info/app

Accounting and Finance for Banking Module A Pdf

Free
Accounting and finance for bankers all ePDFs are available in our an app. Get them all at https://iibf.info/app

Accounting and Finance for Banking Module A Pdf

Free
Accounting and finance for bankers all ePDFs are available in our an app. Get them all at https://iibf.info/app

Leave a reply

Please enter your comment!
Please enter your name here

Popular

Free Live Classes

spot_img

More from author

All about KYC/AML Exam by IIBF

All about KYC/AML Exam by IIBF The KYC/AML is a professional certification exam in Anti Money Laundering and Know your customer conducted by the Indian...

CCP- Certified Credit Professional Course by IIBF

IIBF CCP (Certified Credit Professional) exam is an All-India Exam directed by the Indian Institute of Banking and Finance (IIBF) to select competent candidates...

What is Digital Banking in Detail

Digital Banking is the automation of traditional banking services. It is defined as banking done through the digital platform, doing away with all the...

Digital Banking Course By IIBF

Digital Banking Course By IIBF Certificate course in Digital Banking is conducted by IIBF to provide practicing bankers a sound foundation in the digital banking...