Deciphering the Current MSF and Repo Rates
Sometimes banks and lending institutions run out of liquidity, which is a situation similar to individuals facing acute cash crunch. During such an emergency, they are permitted to borrow money from the Reserve Bank of India (RBI) under the Marginal Standing Facility or MSF. Very often, lenders experience financial gaps as a result of a mismatch in their loan and deposit portfolios. These shortages are transient and they may pledge their authorised government securities for a day within the Statutory Liquidity Ratio (SLR) rate provision to receive quick funds from the RBI.
Significance of Marginal Standing Facility (MSF)
The Reserve Bank of India implemented MSF in June 2011 to stabilise overnight lending rates between lenders and to regulate the flow of money with appropriate transmission across the financial system. Under the Liquidity Adjustment Facility (LAF), lenders can obtain money during a severe cash crunch at a rate greater than the repo rate. The MSF rate is typically 25 basis points or 0.25% higher than the repo rate. For instance, while the current MSF rate is 6.75%, the repo rate is presently at 6.50%. Lenders may use this feature to access funds up to 1% of their SLR securities or NDTL (net demand and time liabilities). They commit to this pledge only in an emergency if there is a total freeze in inter-lender liquidity.
How Marginal Standing Facility Works
The interest rate at which the RBI lends money to lenders that are short on liquidity is known as the MSF rate. Lenders can obtain overnight money by paying the MSF rate, which is different from the repo rate. The RBI holds the authority to change the borrowing rates and percentages under MSF to preserve equilibrium in the economy. It may choose to raise the MSF rate while attempting to arrest a decline in the rupee or lower it to simplify fund access for lenders whenever they need immediate cash.
What Is Repo Rate?
The RBI extends short-term loans to lenders against the sale of surplus securities, bonds, etc. at a specific interest rate known as the repo rate or repurchase rate. Lenders can buy back these securities later at a pre-determined price. The RBI lowers the repo rate when it wants to inject liquidity into the market and increases it to make borrowings dearer. Consequently, financial institutions may secure money at lower interest rates when the repo rate falls; whereas, when it rises, financing and credit access get restricted. This is how the RBI manages inflation and currency depreciation while regulating cash flow in the economy.
Principal Distinctions Between MSF Rate and Repo Rate
Here are the main differences between the repo rate and MSF rate:
Why Borrow at the MSF When There is Repo Rate?
The RBI opens the MSF window for lenders in the absence of cash flow in the market. Through this facility, lenders are able to receive money at a higher rate than the repo rate. Additionally, MSF is also necessary to control volatility in overnight lending rates. This is why, lenders choose MSF only during exigencies; at other times, they can obtain finances at current repo rates with ease.
Summing Up
The RBI raises MSF rates either to control excess cash supply in the economy or to halt rupee depreciation against the US dollar. At the same time, a hike in MSF rates makes credit borrowings costly for lenders, which then extends to borrowers, impacting them due to restricted fund flow. At such times, every type of credit – be it secured or unsecured – becomes expensive. Hence, if you are in the midst of a home loan verification process, you might find it difficult to obtain and support the loan because of higher interest rates.
