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Behind the scenes of banking: The role of the marginal standing facility

The MSF is a safety net that provides a source of funds for banks during liquidity stress. Join us to know more.

marginal standing facility

The new operating window for MSF is from 17:30 to 23:59 hours as of March 1, 2022

Picture yourself at a lively party where the music is blaring. Suddenly, the music stops. The DJ’s equipment has failed. But wait, there’s a backup system in place to keep the party going! This is similar to how the Marginal Standing Facility (MSF) works in the banking world. 

It’s like a backup DJ, ready to step in when banks face a liquidity crunch. In this article, we are going to dive into the world of MSF, a fascinating financial instrument that plays a crucial role in maintaining the rhythm of our economy. So, let’s get the party started!

What is Marginal Standing Facility (MSF)?

One instrument of monetary policy used by the Reserve Bank of India (RBI) is the Marginal Standing Facility (MSF). In emergencies when there is a severe shortage of funds, scheduled commercial banks can borrow from the RBI by pledging government assets. For this purpose, the borrowing is done at the MSF rate, which is commonly higher than the repo rate.

The MSF scheme was a key component of the RBI’s 2011–2012 Monetary Policy. This facility’s primary goals are a more stable transmission of monetary funds throughout the financial system and less fluctuation in interbank lending rates overnight.

With the MSF, financial institutions can borrow as much as 2% of their NDTL (Net Demand and Time Liabilities). The borrowing bank repays the amount to the RBI the following day since the borrowing is done overnight.

The difference between the repo rate and the MSF rate is called the MSF spread. This margin currently stands at 25 basis points, indicating that the repo rate is 25 basis points lower than the marginal standing facility rate. Banks will only be allowed to use MSF borrowings if required by the higher rate.

Also read: Unlocking prosperity: The transformative power of financial literacy

History and purpose of MSF

In its monetary policy for 2011 and 2012, the Reserve Bank of India (RBI) introduced the Marginal Standing Facility (MSF). The principal goals of MSF were to reduce interbank market volatility and facilitate smooth monetary transmission.

With MSF, banks have access to a liquidity facility in an emergency. When overnight interbank liquidity is exhausted, banks can borrow funds from the RBI using government assets. This facility becomes very useful when other borrowing options, such as the Liquidity Adjustment Facility (LAF) repo, have been exhausted.

The RBI’s strategy for managing liquidity underwent a sea change with the implementation of MSF. The RBI manages liquidity conditions, impacts short-term interest rates, and affects the cost of borrowing money for banks by changing the MSF rate. Because of its importance in stabilising overnight money market rates, MSF is an integral part of the RBI’s monetary policy framework.

Difference between marginal standing facility and bank rate

ParametersBank rateMSF rate
DefinitionThe bank rate refers to the interest rate at which the central bank lends money to commercial banks without selling securities.The Reserve Bank of India (RBI) offers financial institutions the opportunity to borrow overnight funds at the MSF Rate, with a pledge of government securities serving as collateral.
PurposeThe country’s overall credit situation is managed using the Bank Rate.If a bank experiences an unexpected or emergency shortage of funds, it will borrow at the MSF Rate as a last option.
EligibilityAny commercial bank can apply.Enrollment is limited to scheduled commercial banks that have their Subsidiary General Ledger and Current Account with the Reserve Bank of India (RBI).
CollateralNo collateral is needed to secure the loan at the bank rate.Collateral is required in this case.
Frequency of borrowingThere is no cap on how many times a bank can use the Bank Rate to borrow money.Borrowing under MSF is intended to be done in exceptional circumstances, when there is a severe lack of available funds.
Quantum of fundsBorrowing amounts determined by the Bank Rate are not limited in any way.Under MSF, banks have the option to borrow up to 2% of their NDTL, or net demand and time liabilities.

Also read: Bank rate vs. Repo rate – Understanding the key differences

Impact of MSF on banks and the economy

The MSF is a safety net that provides a source of funds for banks during liquidity stress. Under the MSF, banks can borrow money from the RBI when short on funds by guaranteeing government assets. It enables banks to lend money to people and companies while satisfying their short-term liquidity requirements. Banks are urged to exercise caution with their funds and borrow only when necessary since the MSF rate is greater than the repo rate.

When it comes to the RBI’s monetary policy and the security of the financial system, the MSF is crucial. The RBI can control inflation, manage liquidity, and affect short-term interest rates by adjusting the MSF rate. Since banks will have a cheaper cost of borrowing money with a lower MSF rate, economic activity can be encouraged. In comparison, a higher rate can help stabilise the economy, reduce inflation, and tighten liquidity.

Recent changes in MSF

Recently, the Reserve Bank of India (RBI) made multiple changes to the Marginal Standing Facility (MSF).

Adjusting the MSF window timings was one significant change. The new operating window for MSF is from 17:30 to 23:59 hours as of March 1, 2022. The MSF operations were rescheduled to better coincide with market timings.

One more major change that went into effect on December 30, 2023, was the decision to let the Standing Deposit Facility (SDF) and MSF reverse liquidity, even on holidays and weekends. This decision addressed the situation that arose from the banks’ simultaneous high utilisation of both facilities.

On May 22, 2020, the RBI (Reserve Bank of India) made a noteworthy announcement about the rate of the Marginal Standing Facility (MSF). The decision to reduce the policy Repo rate, which is part of the Liquidity Adjustment Facility (LAF), by 40 basis points was made by the Monetary Policy Committee (MPC), according to the Monetary Policy Statement for the fiscal year 2020-21. 

Because of this cut, the rate is now 4.00% instead of 4.40%. Immediate effects of the change include a reduction from 4.65% to 4.25% in the marginal standing facility rate, which is typically set at a margin above the repo rate.

These adjustments are part of the RBI’s continuous efforts to control the liquidity of the money market and banking system. They show how the RBI has adjusted its liquidity management strategy to meet changing market demands.

Also read: RBI MPC meeting: Repo rate unchanged, what does it mean for you?

Bottomline

In times of severe liquidity shortages, the Marginal Standing Facility (MSF) steps in to protect financial institutions. It’s not merely a policy or a rate; it’s a mechanism that helps maintain economic stability. The MSF rate, adjusted by the Reserve Bank of India (RBI), plays a significant role in managing liquidity conditions and influencing short-term interest rates in the economy. 

Thus, understanding the MSF is vital for those with an interest in understanding how the financial industry functions. That’s the essence of our discussion on the Marginal Standing Facility. Happy reading!

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StockGro Team

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