Liquidity Adjustment Facility

The Liquidity Adjustment Facility (LAF) is a monetary policy instrument employed by central banks, including the Reserve Bank of India (RBI), to regulate liquidity in the economy and oversee short-term interest rates.

Illustration:

Imagine a situation where banks face a temporary shortage of funds needed for routine operations. Through the Liquidity Adjustment Facility (LAF), they can obtain short-term liquidity from the RBI by offering government securities as collateral. This arrangement helps them meet immediate requirements and supports stability in short-term interest rates. On the other hand, when banks have surplus cash, they can place that money with the RBI under LAF and earn interest on it. Through these mechanisms, LAF enables the RBI to regulate the overall liquidity conditions in the financial system.