Guiding Principles for the conduct of Liquidity Adjustment Facility

Here are the guiding principles for the conduct of Liquidity Adjustment Facility (LAF) in India, along with some multiple choice questions and answers:

Guiding Principles

• The LAF should be used to manage liquidity in the banking system in a way that is consistent with the overall objectives of monetary policy.
• The LAF should be conducted in a transparent and predictable manner.
• The LAF should be accessible to all banks on a fair and non-discriminatory basis.
• The LAF should be used to promote financial stability.

Multiple Choice Questions

1. Which of the following is NOT a guiding principle for the conduct of LAF?
   • It should be used to manage liquidity in the banking system in a way that is consistent with the overall objectives of monetary policy.
   • It should be conducted in a transparent and predictable manner.
   • It should be accessible to all banks on a fair and non-discriminatory basis.
   • It should be used to promote economic growth.
   • The correct answer is (d). LAF is a monetary policy tool, and its primary objective is to manage liquidity in the banking system. Economic growth is a secondary objective.
2. The LAF is conducted through two types of operations:
   • Repo auctions
   • Reverse repo auctions
   • Which of the following statements is NOT correct about repo auctions?
     • Banks can borrow money from the RBI through repo auctions.
     • The RBI sets the repo rate, which is the interest rate at which banks can borrow money from the RBI.
     • The repo rate is typically lower than the reverse repo rate.
     • The repo rate is used to inject liquidity into the banking system.
   • The correct answer is (c). The repo rate is typically higher than the reverse repo rate. This is because the RBI is lending money to banks through repo auctions, and it typically charges a higher interest rate for lending money than it pays for borrowing money.
3. The LAF is used to promote financial stability by:
   • Helping to prevent liquidity crises
   • Providing liquidity to banks during periods of stress
   • Reducing the risk of bank runs
   • All of the above
   • The correct answer is (d). All of the above are ways in which the LAF can be used to promote financial stability.

Conclusion

The LAF is an important tool for the RBI to manage liquidity in the banking system and promote financial stability. By following the guiding principles outlined above, the RBI can ensure that the LAF is used effectively and efficiently to achieve its objectives.