Liquidity Adjustment Facility

Introduction

• The Liquidity Adjustment Facility (LAF) is a facility provided by the Reserve Bank of India (RBI) to scheduled commercial banks that allows them to borrow money via repo or park excess funds with the RBI via reverse repo. 
• The Liquidity Adjustment Facility (LAF) is a tool used by the Reserve Bank of India to manage commercial banking’s liquidity demands. 
• It helps banks correct day-to-today liquidity imbalances. 

Components of LAF

Repo rate

• The interest rate charged by the RBI for short-term loans to commercial banks is known as the repo rate or repurchase rate. 
• Banks obtain funds from the RBI by selling securities and agreeing to repurchase them at a later date at a mutually agreed-upon price. 
• Government securities, corporate securities, or any other securities that the government allows for the transaction can be utilised in Repo Rate. y Bank usually uses this route to fulfill short term liquidity crunch. 
• The policy rate is also known as the repo rate. 
• A change in the policy rate will have an impact on all other short-term interest rates in the economy, affecting economic growth and inflation.
• Repo Rate is of two types based on maturity:

1. Overnight Repo: It refers to the Repo with single-day maturity. The Indian Repo market is dominated by the overnight Repo market. 
2. Term Repo: It refers to Repo that has a fixed maturity longer than one day

Reverse Repo Rate: 

• When the RBI borrows money from commercial banks, it pays them a rate of interest called reverse repo. 
• A reverse repo is one kind of loan that is designed to absorb excess liquidity in the economy. 
• The Reverse Repo Rate, set by the RBI, allows banks to earn interest on excess cash. This serves two purposes:

1. Reduces excess liquidity from the economy. 
2. Lower loan disbursal by banks hence prevent bank losses due to NPA. 
3. Increases in Reverse Repo will reduce money supply by encouraging banks to park their funds with the RBI in order to earn interest, and vice versa.

Long Term Repo Operation (LTRO)

• Under LTRO, RBI will conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of Rs 1 lakh crore at the policy repo rate.
• The RBI introduced LTRO with a view to assuring banks about the availability of durable liquidity at reasonable cost relative to prevailing market conditions, and to further encourage banks to undertake maturity transformation smoothly and seamlessly so as to augment credit flows to productive sectors.