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Liquidity Adjustment Facility


Liquidity Adjustment Facility: Hi, Friends Today I am going to share some interesting information on the topic of Liquidity Adjustment Facility.

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Liquidity Adjustment Facility

What is a Liquidity Adjustment Facility?

A Liquidity Adjustment Facility that is LAF is a tool used in the monetary policy. It is mainly by the Reserve Bank of India that is RBI.  Allows banks to borrow the money through repurchase agreements. The repos or to make loans to the Reserve Bank of India through the reverse repo agreements.

This arrangement is effective in managing the liquidity pressures. Also, it is assuring basic stability in the financial markets. In the United States, the Federal Reserve conducts repos and reverses the repos under its open market operations.

The Reserve Bank of India introduced the LAF as a result of the Narasimham Committee. On the Banking Sector Reforms in the year 1998.

The Basics of LQA

Liquidity adjustment facilities are used to help the banks in resolving any short-term cash shortages. During periods of economic instability or from any other form of stress. Which is caused by forces beyond their control.

Various banks use having the right to do the securities. As the collateral through a repo agreement. Also, use the funds to suffering their short-term requirements. Thus remaining stable.

The facilities are implemented on a day-to-day basis. As many banks and other financial institutions ensure they have enough capital in the overnight market. The transacting of liquidity adjustment facilities is taking place.

That is an auction at a set time of the day. An independent wishing to raise the capital to fulfill a shortfall engages in repo agreements. While one with excess capital does the opposite and. It also put into effect a reverse repo.

LQA Facility and the Economy

The Reserve Bank of India can use the liquidity adjustment facility. To manage the high levels of a general increase in prices. Also, fall in the purchasing value of money. It does so by increasing the repo rate. Which raises the cost of servicing debt. This is in turn, reduces the investment and also money supply in India’s economy.

Introducing a statement, if the Reserve Bank of India is trying to encourage the economy. After a period of slow economic growth. It can also lower the repo rate to encourage businesses to borrow. Thus increasing the money supply.

Recently, the Reserve Bank of India cut the repo rate by 40 basis points in the year May 2020. To 4.00% from 4.40% earlier. Due to weak economic activity, gentle and kindly inflation, and also the slower global growth. At the same time, the reverse repo rate was cut to 3.35% from 3.75%.

Also a downfall of 40 basis points. The cuts mirror monetary policy decisions are made by central banks. Around the world in the spring and also summer of the year 2020. As the governments have attempted to temper the economic effect of the COVID-19 pandemic situations.

LQA Example

Let us assume if a bank has a short-term cash shortage. Due to a recession firmly holding the attention of the Indian economy. The bank would use the Reserve Bank of India’s liquidity adjustment facility.

By executing a repo agreement and by selling the government securities to the Reserve Bank of India in return for a loan. With an agreement to repurchase those securities back.

For example, let us say the bank needs a one-day loan for around 50,000,000 Indian rupees. Executes a repo agreement at 6.25%. The bank’s payable interest on the loan is around Rs. 8,561.64. That is Rs. 50,000,000 x 6.25% / 365.

Now let’s suppose the economy is expanding. The bank has excess cash on hand. In this case, the bank would execute a reverse repo agreement by making a loan to the Reserve Bank of India. In the exchange for government securities.

In which it agrees to repurchase those securities. For example, the bank may have Rs. 25,000,000 available to loan the Reserve Bank of India.

It decides to execute a one-day reverse repo agreement at 6%. The bank would receive the amount of Rs. 4109.59 in interest from the Reserve Bank of India. That is Rs. 25,000,000 x 6% / 365.

So, this is the important information on the topic of Liquidity Adjustment Facility. Here I have mentioned the Meaning, Basics, its Adjustment, and Economy.

If any Queries or Questions is persisting then, please comment on the viewpoints.

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