Marginal Standing Facility
- Marginal Standing Facility (MSF) is a window for scheduled banks to borrow overnight from the RBI in an emergency situation when interbank liquidity dries up completely.
- Under interbank lending, banks lend funds to one another for a specified term.
- Banks borrow from the RBI by pledging government securities at a rate higher than the repo rate under the Liquidity Adjustment Facility (LAF).
- The repo rate is the rate at which the RBI lends money to commercial banks against securities in the event of a shortfall of funds.
- Loans provided at repo rate are provided for a specified period with an obligation that the bank will repurchase the securities back at a predetermined rate.
Repo and Reverse Repo Rates
- The repo rate is the rate at which the central bank of a country (RBI in the case of India) lends money to commercial banks in the event of any shortfall of funds. Here, the central bank purchases the security.
- The reverse repo is the interest rate that the RBI pays to the commercial banks when they park their excess “liquidity” (money) with the RBI. The reverse repo, thus, is the exact opposite of the repo rate.
Significance
- Under normal circumstances, that is when the economy is growing at a healthy pace, the repo rate becomes the benchmark interest rate in the economy.
- That’s because it is the lowest rate of interest at which funds can be borrowed. As such, the repo rate forms the floor interest rate for all other interest rates in the economy – be it the rate for a car loan or a home loan or the interest earned on fixed deposit etc.
- When the RBI pumps more and more liquidity into the market there are no takers of fresh loans — either because the banks are unwilling to lend or because there is no genuine demand for new loans in the economy.
- In such a scenario, the action shifts from repo rate to reverse repo rate because banks are no longer interested in borrowing money from the RBI.
- Rather they are more interested in parking their excess liquidity with the RBI. And that is how the reverse repo becomes the actual benchmark interest rate in the economy.
Differences between Repo Rate and Marginal Standing Facility
- Repo rate is the rate at which RBI lends money to commercial banks, while MSF is a rate at which RBI lends money to scheduled banks.
- The repo rate is given to banks that are looking to meet their short-term financial needs. While, the MSF is meant for lending overnight to banks.
- Lending at repo rates involves a repurchase agreement of securities. While it is not so in MSF.
- Under MSF, banks are also allowed to use the securities that come under Statutory Liquidity Ratio (SLR) in the process of availing loans from RBI.
- Under SLR, commercial banks are mandated by RBI to maintain a stipulated proportion of their deposits in the form of liquid assets like cash, gold and unencumbered (free from debt) securities.
What is a Standing Deposit Facility & Its Role?
- The RBI has introduced the Standing Deposit Facility (SDF), an additional tool for absorbing liquidity.
- The SDF allows banks to deposit funds at the RBI without the need to provide collateral. It serves as a safety valve for the banking system, where banks can park their excess liquidity.
- Background: In 2018, the amended Section 17 of the RBI Act empowered the RBI to introduce the SDF.
- Modus Operandi: By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy.
- The SDF is also a financial stability tool, and its role is in liquidity management.
- The SDF rate will be 25 bps below the policy rate (Repo rate), and it will be applicable to overnight deposits at this stage.
- It would, however, retain the flexibility to absorb liquidity of longer tenors as and when the need arises, with appropriate pricing.
- Need: The “extraordinary” liquidity measure was undertaken in the wake of the pandemic.
- The main purpose of SDF is to reduce the excess liquidity in the system and control inflation.
- Implementation: The RBI will engage in a gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner.
