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Liquidity Adjustment Facility (LAF): meaning and the rate corridor
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The liquidity adjustment facility (LAF) is the set of windows through which the RBI manages day-to-day cash in the banking system. When banks are short of money the RBI lends to them; when banks have too much, the RBI takes it in. It was introduced in stages from June 2000, following the Narasimham Committee on banking sector reforms, and became the RBI's main liquidity tool.
The windows today
| Direction | Window | What happens |
|---|---|---|
| RBI injects cash | Repo (fixed rate and variable rate) | Banks borrow against government securities |
| RBI injects cash in an emergency | Marginal standing facility | Overnight borrowing at a higher rate |
| RBI absorbs cash | Standing deposit facility | Banks deposit without collateral |
| RBI absorbs cash, if it chooses | Reverse repo (fixed and variable) | Banks lend against securities |
The corridor
The repo rate is the policy rate. The SDF rate is the floor and the MSF rate is the ceiling. Overnight money-market rates, especially the weighted average call rate in the call money market, are expected to trade inside this band. Since April 2022 the band has been 25 basis points on each side of the policy rate (RBI Monetary Policy Statements, rbi.org.in), but this is the RBI's choice and it widened the band during the Covid period.
Variable-rate operations
Besides overnight windows, the RBI holds auctions for 7-day, 14-day and longer tenors (variable rate repo and reverse repo) to match liquidity needs of different lengths.
LAF versus open market operations
The LAF handles short-term, temporary liquidity. Open market operations buy or sell securities outright to change liquidity for the long run. Both are quantitative tools, as are CRR and SLR.
How bank exams ask about it
Questions run along three lines: "LAF consists of", "which committee recommended LAF" (Narasimham), and "floor and ceiling of the corridor". Many papers also ask a one-liner definition of "liquidity". If you remember the order SDF, repo, MSF, you will not be tripped by the options. Put it with the other policy tools in banking awareness.
Where to find current figures
The rates for each window are on the RBI's home page and in the policy statements at rbi.org.in.
Frequently asked questions
Is the LAF only about repo and reverse repo?
That was the textbook answer for years. Now the SDF and MSF also form part of the framework, so a recent question may include all four.
Who participates in the LAF?
Scheduled commercial banks (other than regional rural banks) and primary dealers that hold the required current and securities accounts with the RBI.
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- Repo rateRepo rate is the rate at which the RBI lends short-term money to banks against government securities. How it works, what a change does and how exams ask it.
- Reverse repo rateReverse repo rate is what the RBI pays when it borrows from banks against government securities. Meaning, how it differs from repo and its status after SDF.
- Standing deposit facilityThe standing deposit facility lets banks park surplus funds with the RBI without collateral and sets the floor of the rate corridor. Meaning and exam facts.
- Marginal standing facilityThe marginal standing facility is the RBI window where banks borrow overnight in an emergency by dipping into their SLR holdings. Meaning, rate and exam facts.
- Open market operationsOpen market operations are the RBI buying or selling government securities to add or drain cash. Meaning, OMO vs LAF, Operation Twist and exam facts.
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