Liquidity Adjustment Facility is the mechanism by the RBI through which the central bank manages the liquidity needs of the commercial banking system.
The LAF, introduced in June 2000, emerged as the major instrument of monetary policy, supporting liquidity needs of the banking system by the RBI. Main purpose of LAF is to provide liquidity or immediate cash needs to the banks when they are short of liquidity. Similarly, it absorbs liquidity from the system (banking) when the banks have excess money with them. Given banks are the dominant institutions in the economy, the LAF becomes a liquidity support mechanism for the entire economy by the RBI.
The LAF has two legs – repo and the reverse repo. If repo provides (injects) liquidity into the banking system, reverse repo receives (absorbs) liquidity from the system. The RBI injects or absorbs liquidity in accordance with the application submitted by commercial banks.
Banks can avail the repo and reverse repo facilities from Monday to Friday. An application for repo can be submitted to the RBI in the morning by a bank and the central bank gives money after examining the application by the concerned bank.
