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What is a Liquidity adjustment facility?

by Uddipana Gogoi

Liquidity adjustment facility is a technique/tool of monetary policy of the Reserve Bank of India. It allows commercial banks to borrow from the Reserve Bank of India. It was introduced from June 5, 2000, to impart greater stability and facilitate the emergence of a short term rupee yield curve. Thus, LAF helps banks to quickly borrow money in case of any emergency or for adjusting in their Statutory Liquidity Ratio (SLR)/Cash Reserve Ratio (CRR) requirements. Accordingly, it facilitates short term borrowings and lendings between commercial banks and the RBI in the form of-

  • Repo – Commercial bank borrows from RBI for a short period.
  • Reverse repo- Here, RBI gets back the money/borrowed money from commercial banks for a short period.

Features of Liquidity adjustment facility

  1. Firstly, It is a technique of monetary policy of the RBI.
  2. Secondly, It facilitates repo and reverse repo transactions.
  3. Furthermore, It facilitates short term liquidity adjustment of financial market.
  4. Accordingly, all Scheduled Commercial Banks (excluding Regional Rural Banks) and Primary Dealers (PDs) having Current Account and SGL Account with Reserve Bank, Mumbai will be eligible.
  5. Moreover, receipt of bill for a minimum amount of Rs.5 crore and in multiples of Rs. 5 crore thereafter.
  6. Finally, The eligible securities for LAF are all SLR-eligible transferable Government of India dated Securities/Treasury Bills.
  7. The amount of securities offered or tendered on acceptance of a bid for Rs.100 will be Rs.105 in terms of face value.

Importance of LAF

  1. LAF facilitates commercial banks and primary dealers of the money market to borrow to manage their short term liquidity crisis.
  2. It controls inflation of an economy by managing the short term liquidity circulation of the economy.
  3. It facilitates stimulation of an economy after slow economic growth.

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