RBI substitutes second LAF for costlier MSF

The additional Liquidity Adjustment Facility (LAF) given to banks to tide over the funds crunch during the second half of financial year 2010-11 was withdrawn on Monday. Banks will get another route to borrow funds, but at a more expensive rate.

The second LAF was being conducted from end-January till this Friday. Banks were borrowing at 7.25 per cent to meet the shortfall in reserve requirements. In the new Marginal Standing Facility (MSF), banks will have to borrow at 100 basis points more than the repo rate, which is 7.25 per cent now.

While borrowing from the second LAF was a regular exercise, the Reserve Bank of India (RBI) says MSF can be availed only under exceptional circumstances. It issued the MSF guidelines on Monday. While banks are mandated to maintain at least 24 per cent of all net demand and time liabilities (NDTL) as the Statutory Liquidity Ratio, they may borrow overnight up to one per cent of their respective NDTL under the MSF scheme.

The one per cent leeway was earlier available at the repo rate. Currently the repo rate is 7.25 per cent, reverse repo at 6.25 per cent and the MSF is at 8.25 per cent.

RBI governor D Subbarao had said in the annual monetary and credit policy announcement last week that the MSF was an exceptional facility and banks were expected to exhaust the opportunities in the market repo and Collateralised Borrowing and Lending Obligations (CBLO) before accessing the MSF.

As a result in a liquidity deficit situation, the short-term rates like call money, CBLO and market repo will move in the corridor between the repo rate and the MSF rate. “In case these rates go beyond the MSF rate, it will attract RBI’s attention and may prompt a liquidity easing action,” said a bond dealer with a public sector bank.

Also, MSF requests would not be made public, unlike the case in LAF auctions. “The declaration of MSF transactions may shock the call money market, as it will clearly show that liquidity situation is tight and banks are borrowing at a penal rate,” said a treasury head with a public sector bank. The MSF will be conducted on the lines of the LAF repo between 3.30 and 4.30 pm.

The working group on the operating procedure of monetary policy, chaired by RBI executive director Deepak Mohanty, had recommended permanent continuation of this facility. The repo borrowings in the second LAF were higher than the initial auction everyday, indicating that banks were heavily using the second LAF window. “The second LAF was helpful, as the RTGS (Real Time Gross Settlement) transactions are higher towards the end of the day and so would be the need for funds,” said the treasury official.