Operations of the LAF or, the Liquidity Adjustment Facility

Operations of the LAF or, the Liquidity Adjustment Facility

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Banks have access to the LAF or, the Liquidity Adjustment Facility from Monday through Friday; Every day, the RBI, the central bank, holds an auction, and banks are required to submit their repo and reverse repo bids by 10:30 a.m. At noon, the auction's outcome is announced. There are two types of LAF RBI available:

A repo operation - is a facility for short-term collateralized lending. In exchange for cash reserves, the owner of securities sells those securities to a buyer. At a predetermined rate and on a predetermined date, the seller promises to repurchase the sold securities. The repo rate is the rate at which the lender (the RBI) transfers funds to the borrower (banks).

Reverse Repo Operation - Unlike a repo operation, a reverse repo operation is not a transaction. It provides institutions with unused cash with a chance to earn some interest on it. In switch repo activity, the moneylender of assets gets protections from a dealer with a consent to exchange on a predefined date and rate. Note: The RBI cannot pay more on deposits than they charge on loans, which is why the reverse repo rate is always lower than the repo rate. When the repo rate is changed by the RBI, the reverse repo rate is also changed automatically.

The liquidity adjustment facility, also known as the economy's LAF - can be utilized by the RBI to control high inflation rates. It achieves this by raising the repo rate, which raises the expense of obligation overhauling. India's economy sees a decrease in investment and money supply as a result. Conversely, to invigorate the economy after a time of slow development, it can bring down the repo rate to urge organizations to get, in this way expanding the cash supply. Allow us to delineate this with a model. Due to weak economic activity as a result of benign inflation, the COVID outbreak, and slower global growth, the RBI decreased the repo rate by 40 basis points in May 2020 to 4.00%. The reverse repo rate was lowered by 40 basis points to 3.35 percent from 3.75 percent simultaneously. The RBI lowered the repo rate because the year 2020 did not turn out to be financially prosperous. As a result, there was more money available from banks to businesses and even between individuals.