Policy Corridor (LAF Corridor) Flashcards
What is the Policy Corridor (or LAF Corridor)?
The Policy Corridor (or Liquidity Adjustment Facility Corridor) is a tool used by the Reserve Bank of India to manage liquidity in the banking system.
It consists of a set of interest rates that guide short-term borrowing and lending for banks.
What interest rates make up the Policy Corridor?
Marginal Standing Facility (MSF): The ceiling of the corridor, where banks can borrow from the RBI at a higher rate (repo rate + 25 bps).
Repo Rate: The central rate at which the RBI lends to banks.
Standing Deposit Facility (SDF): The floor of the corridor, where banks can deposit funds with the RBI at a lower rate (repo rate - 25 bps).
How did the Policy Corridor change in April 2022?
The Standing Deposit Facility (SDF) replaced the Reverse Repo Rate as the floor of the Policy Corridor.
This change maintained the width of the corridor at 50 basis points.
Why is the Policy Corridor important?
It helps the RBI control the money supply in the economy.
It influences short-term interest rates in the banking system.
A wider corridor means more flexibility for banks, while a narrower corridor means stricter RBI control.
What is the relationship between the Policy Corridor and the call money rate?
The call money rate is the overnight rate at which banks borrow from each other.
Ideally, the call money rate should stay within the boundaries of the Policy Corridor.
What is the difference between the MSF and the SDF?
MSF (Marginal Standing Facility): Acts as a safety net for banks to borrow from the RBI during liquidity shortages. The interest rate is higher than the repo rate.
SDF (Standing Deposit Facility): Allows banks to park excess funds with the RBI, earning an interest rate lower than the repo rate.
How does the RBI use the Policy Corridor to influence interest rates?
Widening the corridor: Gives banks more flexibility to set their own interest rates, potentially leading to competition and lower rates for borrowers.
Narrowing the corridor: Restricts banks’ flexibility, leading to more control by the RBI over short-term interest rates.
What factors might lead the RBI to adjust the width of the Policy Corridor?
Inflation: High inflation might lead the RBI to narrow the corridor to discourage borrowing and reduce money supply.
Economic growth: To stimulate economic growth, the RBI might widen the corridor to make borrowing easier for businesses and individuals.
Market conditions: The RBI monitors overall liquidity in the banking system and adjusts the corridor accordingly.
What was the rationale behind introducing the SDF?
Liquidity Management: The SDF provides a more permanent tool for absorbing excess liquidity compared to the variable reverse repo rate.
Normalization: It marks a step towards normalizing monetary policy operations after the pandemic-era measures.
Describe the Policy Corridor BEFORE April 2022.
Components: MSF (ceiling), Repo Rate (center), Reverse Repo Rate (floor)
Width: The difference between MSF and Reverse Repo Rate determined the width.
Call Money Rate: Ideally, the overnight inter-bank lending rate stayed within this corridor.
What was the key change to the Policy Corridor AFTER April 2022?
Introduction of SDF: The Standing Deposit Facility (SDF) replaced the Reverse Repo Rate as the floor of the corridor.
Maintained Width: The width of the corridor remained at 50 basis points (MSF at repo + 25 bps, SDF at repo - 25 bps).
Why was the SDF introduced?
Better Liquidity Management: SDF offers a more stable tool for absorbing excess liquidity in the banking system.
Policy Normalization: A step towards returning to normal monetary policy operations after pandemic-related measures.
Despite the introduction of SDF, what is the role of the Reverse Repo Rate?
The Reverse Repo Rate is not fully discontinued.
The RBI retains the option to use the Reverse Repo Rate for flexible liquidity management when needed.
