Monetary Policy announcement simplified.... Courtesy ET

Marginal standing facility is a window for banks
to borrow from Reserve Bank of India in
emergency situation when inter-bank liquidity
dries up completely.
KOLKATA: Reserve Bank of India's new governor
Raghuram Rajan has announced his first monetary
policy on Friday. He has lowered the marginal
standing facility rate by 75 basis points to 9.5%
from 10.25% but raised the policy repo rate under
the liquidity adjustment facility by 25 basis points to
7.5% from 7.25%. Both the measures are effective
from today.
What is marginal standing facility?
Marginal standing facility is a window for banks to
borrow from Reserve Bank of India in emergency
situation when inter-bank liquidity dries up
completely. Banks borrow from the central bank by
pledging government securities at a rate higher than
the repo rate under liquidity adjustment facility or
LAF in short
What is liquidity adjustment facility?
Reserve Bank of India's liquidity adjustment facility
of LAF helps banks to adjust their daily liquidity
mismatches. LAF has two components -- repo
(repurchase agreement) and reverse repo. When
banks need liquidity to meet its daily requirement,
they borrow from RBI through repo. The rate at
which they borrow fund is called the repo rate.
When banks are flush with fund, they park with RBI
through the reverse repo mechanism at reverse repo
rate.
What is the policy rate?
Repo rate is considered as the policy rate as repo is
the widely used instrument between banks and RBI.
Earlier bank rate was considered as the benchmark
but it has lost its relevance as banks seldom take
refinance from RBI at bank rate. Any change in repo
rate signals RBI's interest rate stance.
Why RBI reduced marginal standing facility rate
while it raised repo rate?
RBI had raised the marginal standing facility rate to
10.25% as a liquidity tightening measure and to
prevent speculative use of rupee in buying dollar.
Now, a reduction in the MSF rate perhaps indicate
that RBI is now comfortable about the rupee-dollar
movement. The rupee has bounced back some 8%
from its record low of 68.80 in the last fortnight.
The rupee-outlook has also improved as the Federal
Reserve refrained from reducing the amount of its
bond purchases under quantitative easing
programme. Global investors were earlier
withdrawing their investment in emerging countries
to seek better returns in dollar-denominated
investment withdrawal of quantitative easing means
fall in liquidity and rise in bond prices in the US.
On the other hand, RBI increased the repo rate as it
wants to continue its fight against inflation, which is
still on the higher side above RBI's comfort level.
Rise in repo rate may push borrowing rates up for
both companies and individuals. Companies may
have to shell more interest rate for borrowing for
building new projects or expanding an existing one.