The Liquidity Adjustment Facility is the RBI's primary monetary policy tool for managing short-term liquidity in the banking system, operating through a corridor of interest rates that signals the central bank's policy stance.
Under the LAF, commercial banks borrow overnight funds from the RBI at the repo rate by selling eligible government securities with a simultaneous agreement to repurchase them. This collateralised mechanism ensures credit risk mitigation for the RBI while providing banks short-term liquidity support.
The Marginal Standing Facility allows banks to borrow from the RBI at a rate set above the repo rate — typically by 25 basis points — forming the upper bound of the interest rate corridor. Banks can access MSF even by dipping into their Statutory Liquidity Ratio holdings, making it a genuine emergency window.
Introduced in April 2022, the Standing Deposit Facility replaced the reverse repo rate as the effective floor of the LAF corridor. Its defining feature is that banks park surplus liquidity with the RBI without receiving any collateral in return, freeing the RBI's balance sheet from the constraint of holding government securities against every absorption operation.
The corridor — bounded by the SDF rate at the bottom and the MSF rate at the top — anchors overnight interbank rates close to the policy repo rate. A narrow, symmetric corridor signals greater monetary policy precision and reduces volatility in money markets.
The LAF corridor has evolved from a simple repo-reverse repo framework to a more flexible architecture. Sustaining its effectiveness requires calibrated liquidity management that balances inflation control with adequate credit flow to the productive economy.
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