3. Banking Important Terms & Its Concpets

A. THE LIQUIDITY ADJUSTMENT FACILITY (LAF)

The Liquidity Adjustment Facility (LAF) is a monetary policy tool used by the Reserve Bank of India (RBI) to manage liquidity in the banking system and regulate short-term interest rates. The LAF allows banks to borrow or lend funds on an overnight basis against eligible securities.

The key details about the Liquidity Adjustment Facility (LAF) :

1. Purpose :

The LAF was introduced by the RBI as part of its monetary policy framework. It aims to ensure stability in the money market and manage liquidity conditions in the economy.

2. Components :

The LAF consists of two components : a. Repo (Repurchase Agreement): b. Reverse Repo.

3. Eligible Participants :

Scheduled commercial banks, excluding regional rural banks (RRBs), are eligible to participate in the LAF.

4. Security Collateral :

Banks can borrow or lend funds under the LAF by pledging eligible securities as collateral. The RBI determines the eligible securities and the applicable haircuts (margins) for each security.

5. Tenure :

The LAF transactions are typically conducted on an overnight basis, meaning the borrowing or lending is for one day. However, the RBI may conduct longer-term repo operations to manage liquidity conditions in the economy.

6. Role in Monetary Policy :

The LAF plays a significant role in the RBI's monetary policy operations. By adjusting the repo rate, the RBI influences the cost of borrowing for banks, which, in turn, affects short-term interest rates in the economy. The LAF operations help the RBI manage liquidity and implement its monetary policy stance.

7. Reporting and Monitoring :

Banks are required to report their LAF transactions and collateral holdings to the RBI regularly. The central bank closely monitors the LAF operations to ensure proper liquidity management and financial stability.

B. CASH RESERVE RATIO(CRR) & STATUTORY LIQUIDITY RATIO(SLR)

CRR & SRR are the monetary policy tools used by Reserve Bank of India to regulate and control the money supply in an economy:

1. CASH RESERVE RATIO (CRR) :

CRR is the percentage of a commercial bank's total deposits that it must hold as reserves in the form of cash with the Reserve Bank of India. It is a requirement set by the Reserve Bank of India to ensure that banks maintain a certain level of liquidity. The purpose of CRR is to control inflation, influence lending capacity, and stabilize the banking system. When banks hold a higher percentage of their deposits as reserves, it reduces the amount of money available for lending and helps in curbing inflation. Conversely, a lower CRR frees up more funds for lending and stimulates economic growth. By adjusting the CRR, Reserve Bank of India can regulate the liquidity in the banking system.

2. STATUTORY LIQUIDITY RATIO (SLR):

The Statutory Liquidity Ratio is similar to the CRR but with a different set of assets. SLR is the percentage of a bank's total deposits that it must maintain as specified liquid assets, such as cash, gold, government securities, or other approved securities. SLR serves as a measure to ensure banks have a certain level of liquidity by holding liquid assets that can be quickly converted into cash when needed. The primary objective of SLR is to maintain the stability of the banking system and protect depositors' interests. It also helps the Reserve Bank of India to control credit flow in the economy. By adjusting the SLR, the Reserve Bank of India can influence the liquidity position of banks and impact their lending capacity .

It's worth noting that both CRR and SLR are regulatory measures that impose certain requirements on commercial banks. These tools enable the Reserve Bank of India to manage the money supply, control inflation, and influence lending activities in the economy. The specific percentages for CRR and SLR are determined by the Reserve Bank of India and may vary over time based on economic conditions and policy objectives.

AS ON 06.04.2023
CRR RATE	4.5 %
SLR RATE	18.00 %

C. REPO (REPURCHASE OBLIGATION) AND REVERSE REPO

Repo (Repurchase Obligation) and Reverse Repo are two important tools used in the monetary policy operations of central banks including the Reserve Bank of India:

1. REPURCHASE OBLIGATION (REPO) :

Repo is a transaction where the RBI buys securities (such as government bonds) from commercial banks or financial institutions with an agreement to sell them back in the future. It involves two parties that the RBI as the buyer and the commercial bank as the seller. The commercial bank sells the securities to the RBI and agrees to repurchase them at a specified future date and at an agreed-upon price, which includes an interest rate called the Repo Rate.

Repo transactions serve as a short-term borrowing mechanism for banks, allowing them to raise funds by temporarily transferring their securities to the RBI. The difference between the sale price and the repurchase price represents the interest or repo rate charged by the RBI. This rate is a key tool used by the central bank to influence the liquidity and borrowing costs in the economy.

2. REVERSE REPURCHASE OBLIGATION (REVERSE REPO) :

Reverse repo is the opposite of a repo transaction. In a reverse repo, the central bank acts as the seller of securities and the commercial bank or financial institution acts as the buyer. The central bank sells securities from its portfolio to banks or financial institutions with an agreement to repurchase them at a later date.

Reverse repo transactions are used by the central bank to absorb excess liquidity from the banking system. Banks invest their surplus funds by purchasing securities from the central bank, earning interest on those investments. The interest rate paid by the central bank in a reverse repo is called the reverse repo rate, and it serves as a tool to manage liquidity and control inflationary pressures.

Both repo and reverse repo transactions play a significant role in the central bank's efforts to regulate liquidity, influence interest rates, and manage monetary policy in the economy. The RBI conducts regular repo and reverse repo operations as part of its monetary policy framework to maintain stability and control in the financial system.

AS ON 06.04.2023
REPO RATE	6.50%
REVERSE REPO RATE	3.35 %

D. THE MARGINAL STANDING FACILITY (MSF) :

The Marginal Standing Facility (MSF) is a facility provided by the Reserve Bank of India (RBI) to scheduled commercial banks in India. It serves as a window for banks to borrow funds from the RBI on an overnight basis against eligible securities when they face temporary liquidity shortages.

Important factors of the Marginal Standing Facility as follows :

1. Purpose:

The MSF was introduced by the RBI in 2011 as part of its monetary policy framework. It is designed to provide a safety valve to banks when they cannot meet their liquidity requirements through other means, such as the liquidity adjustment facility (LAF).

2. Eligible Participants:

Scheduled commercial banks, excluding regional rural banks (RRBs), are eligible to access the MSF.

3. Security Collateral:

Banks can borrow funds from the RBI under the MSF by pledging government securities or other approved securities as collateral. The RBI determines the eligible securities and the haircut (margin) applicable to each security.

4. Interest Rate:

The interest rate on the funds borrowed through the MSF is typically higher than the repo rate. The RBI sets the MSF rate, which is usually a fixed percentage above the repo rate. The MSF rate acts as a penal rate to discourage banks from excessively relying on this facility.

5. Tenure:

The borrowing under the MSF is typically for an overnight period. Banks can avail of the funds by submitting their request to the RBI during a specified window before the close of the banking business day.

6. Limits and Conditions:

The RBI sets certain limits on the amount of funds that banks can borrow through the MSF. Additionally, banks are subject to certain conditions and reporting requirements while availing of the facility.

7. Role in Monetary Policy:

The MSF plays a crucial role in the RBI's monetary policy operations. By adjusting the MSF rate, the RBI can influence the short-term interest rates, manage liquidity conditions, and signal its stance on monetary policy.

E. BANK RATES

Bank rates refer to the various interest rates at which banks lend or borrow funds. These rates play a crucial role in the financial system and affect borrowing costs, investment decisions, and monetary policy.

1. Bank Rate:

The bank rate is the rate at which the RBI lends funds to commercial banks for longer-term periods, usually beyond 90 days. It is a benchmark rate used in the financial system and can influence lending rates offered by commercial banks.

2. Prime Lending Rate (PLR):

The PLR is the benchmark rate at which banks lend to their most creditworthy customers. It serves as a reference rate for setting lending rates on various loans, such as personal loans and business loans.

3. Base Rate/Marginal Cost of Funds based Lending Rate (MCLR):

The base rate or MCLR is the minimum interest rate set by banks below which they cannot lend to customers. It is determined by considering factors such as the cost of funds, operating expenses, and the desired profit margin.

4. Fixed Deposit (FD) Rates:

Banks offer fixed deposit accounts to customers where they can deposit funds for a specified period at a predetermined interest rate. These rates vary based on the deposit amount, tenure, and prevailing market conditions.

It's important to note that bank rates can vary among different banks and may change over time based on monetary policy decisions, market conditions, and other factors. For the most accurate & up-to-date information on specific bank rates, it is recommended to check with individual banks or refer to official communications and publications from the respective central bank.

AS ON 06.04.2023
MSF RATE	6.75 %
BANK RATE	6.50%

F. OPEN MARKET OPERATIONS (OMO) :

It is a monetary policy tool used by the Reserve Bank of India (RBI) to regulate the money supply and manage liquidity in the economy. OMO involves the buying and selling of government securities (bonds) by the RBI in the open market.

OMO WORKS AS BELOW :

1. BUYING GOVERNMENT SECURITIES:

When the RBI conducts a buy OMO, it purchases government securities from commercial banks, financial institutions, or other market participants. This infusion of money increases the liquidity in the banking system.

2. SELLING GOVERNMENT SECURITIES:

Conversely, in a sell OMO, the RBI sells government securities to banks and market participants. This action reduces the liquidity in the banking system.

THE PRIMARY OBJECTIVES OF OMO IN INDIA ARE:

1. LIQUIDITY MANAGEMENT:

The RBI uses OMO to manage liquidity in the banking system. By buying government securities, it injects funds into the market, increasing liquidity. Conversely, selling government securities absorbs excess liquidity and reduces the money supply.

2. INTEREST RATE MANAGEMENT:

OMO is also employed to influence short-term interest rates. When the RBI buys government securities, it increases the demand for those securities, leading to a decrease in their yield (interest rate). Similarly, selling government securities increases their supply, putting upward pressure on yields.

3. CONTROL INFLATION:

OMO plays a role in controlling inflation. When the RBI wants to curb inflationary pressures, it can sell government securities, which reduces the money supply and restricts credit availability, thereby helping to moderate inflation.

4. MONETARY POLICY TRANSMISSION:

OMO facilitates the transmission of monetary policy actions and signals. By adjusting the level of liquidity in the system, the RBI influences market interest rates, which in turn affects borrowing costs for individuals and businesses.

3. Banking Important Terms & Its Concpets