Liquidity Adjustment Facility (LAF)

How LAF Affects Borrowing and Savings

LAF allows banks to borrow funds from the RBI via repo agreements or deposit excess funds through reverse repo agreements. These rates form a corridor that impacts loan and deposit interest rates. As of February 7, 2025, the RBI reduced the repo rate from 6.50% to 6.25%, while the Standing Deposit Facility (SDF) rate stood at 6.00% and the Marginal Standing Facility (MSF) rate stood at 6.50%. Lower repo rates typically reduce loan interest costs, making borrowing cheaper, but deposit rates may also decline, affecting savers.

Why LAF Matters for Individuals

1. Interest Rate Stability LAF ensures predictable interest rates, helping individuals plan for home loans, education loans, and investments with reduced uncertainty.

2. Credit Availability Liquidity conditions influence loan accessibility. In January 2025, India’s banking system faced a ₹3.15 trillion liquidity deficit, restricting credit availability. By February 2025, liquidity improved to ₹1.81 trillion, easing access to loans.

3. Inflation Control LAF helps manage inflation, ensuring household purchasing power is protected. If inflation rises, the RBI may raise rates, increasing loan costs but benefiting savers. Conversely, rate cuts boost borrowing and investment opportunities.

Challenges of LAF for Personal Finance

Delayed Rate Transmission: Banks do not quickly pass on rate cuts to borrowers. However, they raise rates fast when LAF rates go up. This impacts how affordable loans are.

External Market Factors: Government tax outflows and global economic trends affect LAF effectiveness. This can delay improvements in liquidity.

Liquidity Imbalances: Daily repo auctions and ₹4.5 trillion in RBI liquidity injections are in place. Still, banking liquidity remains unstable, which affects loan and deposit rates.

Final Thoughts

LAF plays a crucial role in determining borrowing costs and credit availability. With recent RBI liquidity measures, 2025 could be a favorable time for borrowers, though savers should adapt investment strategies to optimize returns.