Pursuant to the recommendations of the Narasimham Committee Report on Banking Reforms (Narasimham Committee II), a Liquidity Adjustment Facility (LAF) operated through repo and reverse repo since 5th June 2000 was introduced to be implemented in a phased manner in three stages.

In the first stager under this scheme, (i) Repo auctions (for absorption of liquidity) and (ii) reverse repo auctions (for injection of liquidity) were conducted on a daily basis (except Saturdays). But for the intervening holidays and Fridays, the repo tenor will be one day. On Friday, the auctions will be held for three days maturity to cover the following Saturday and Sunday. With the introduction of the Scheme, the existing Fixed Rate Repo has been discontinued. The liquidity support extended to all scheduled commercial banks (excluding RRBs) and Primary Dealers through Additional Collaterialised Lending Facility (ACLF) and refinance/reverse repos under Level II, have also been withdrawn. Export Refinance and Collateralised Lending Facility (CLF) at Bank Rate, however, continued as per the existing procedures. Like-wise, Primary Dealers could continue to avail of liquidity support at level I at Bank Rate. The funds from the Facility are to be used by the Banks/PDs for their day-to-day mismatches in liquidity. Interest rates in respect of both repos and reverse repos will be decided through cut off rates emerging from auctions on "uniform price" basis conducted by the Reserve Bank of India, at Mumbai.

The second stage envisaged replacement of Collateralised Lending Facility (CLF) and Level I support to PDs by variable rate repo auctions. The minimum bid size was reduced from Rs.10 crore to Rs.5 crore to enable small level operators to participate in LAF auctions. The auction format for LAF was changed from the uniform price auction method to the multiple price auction method to ensure more responsible bidding. The timing for LAF auctions was advanced by 30 minutes, to provide additional time to unsuccessful bidders in LAF auctions to cover up their positions in the short-term money market. A system of information dissemination on aggregate cash balances maintained by scheduled commercial banks (SCBs) with RBI, on a cumulative basis during the reporting fortnight, was introduced with a view to stabilising market expectations and dampening volatility in call rates. Furthermore, RBI introduced longer-term repos up to 14 days and has resorted to fixed rate repos on overnight basis on one occasion.

After extensive consultations with experts and market participants, the policy statement of April 2001 announced the decision to move over to the second phase in graduated steps. For more effective functioning of LAF, certain changes were effected in the operating procedures. These included recasting of auction methods and periods, a strategy for smooth transition of call money market to pure inter-bank market and a comprehensive and coherent programme for rationalisation of liquidity support available to the system. Certain complementary and associated measures in money and government securities markets were also introduced so as to provide considerable operational flexibility to the market participants and facilitate further integration of money market. The second stage of LAF came into operation from May 8, 2001.

As indicated in April 2000 Policy Statement, the scheme of Liquidity Adjustment Facility (LAF) is being introduced progressively in three convenient stages in order to ensure smooth transition. In the first stage, with effect from June 5, 2000, variable rate Repo auctions with the same day settlement were introduced replacing the Additional Collateralised Lending Facility (ACLF) to banks and Level II support to Primary Dealers (PDs). The second stage of LAF envisages replacement of Collateralised Lending Facility (CLF) to banks and Level I support to PDs by variable rate Repo auctions. It was indicated that the effective date for the second stage would be decided in consultation with banks and PDs. Taking the above factors into consideration and on the basis of experience gained in operating LAF coupled with wide ranging consultations with the market participants, it has been decided to revise the earlier LAF Scheme, circulated vide our letter No. 3968/03.75.00/99-2000 dated May 29, 2000. The main features of the revised Scheme, known as LAF Scheme 2001-2002, are as under:

The Scheme

Under the scheme, (i) Repo auctions (for absorption of liquidity) and (ii) Reverse Repo auctions (for injection of liquidity) will be conducted on a daily basis (except Saturdays). But for the intervening holidays and Fridays, the Repo tenor will be one day. On Fridays, the auctions will be held for three days maturity to cover the following Saturday and Sunday. The funds under LAF are expected to be used by the banks for their day-to-day mismatches in liquidity.

Fixed rate Repo auction

RBI will henceforth have an additional option to switchover to fixed rate Repos on overnight basis; but this option is expected to be sparingly used. For the purpose of such Repos, the rates of interest intended to be offered would be announced as part of auction announcement on the previous evening or before 10.00 a.m. on the day of auction, if necessary.

Long term Repo

In addition to overnight Repos, RBI will also have the discretion to introduce longer-term Repos up to 14 day period as and when required.

Rate of Interest

At present, auctions under LAF are conducted on ''uniform price'' basis. It has been decided to introduce ''multiple price'' auction, in place of existing uniform price auction on an experimental basis for one month period during May 2001. Interest rates in respect of both Repos and Reverse Repos will be, accordingly, based on the bids quoted by participants and subject to the cut-off rates as decided by the Reserve Bank of India, at Mumbai. The Repo/Reverse Repo rate in per cent per annum expected by the tenderer will be expressed up to two decimal points rounded off to the nearest 5 basis points. As there will be no adjustment for accrued coupon, the cash flow will depend upon the Repo rate emerging on day-to-day basis.

Mechanics of operations:

1. The LAF auction timing is being advanced by 30 minutes. Bids will be received in tender forms (Annexures I and II) at IDM Cell before 10.30 a.m., as against 11.00 a.m. at present. A separate box for the purpose will be kept at the reception on the Ground floor of the Central Office Building, RBI, Mumbai. Processing of the bids will be done at IDMC. The auction results will be displayed by Mumbai Office by 12.00 noon as against 12.30 p.m. at present.

2. The Repo will be conducted as "Hold in Custody" type, wherein the Reserve Bank of India will act as a custodian for the participants and hold the securities on their behalf in the Repo/Reverse Repo Constituents' Accounts. In pursuant to this, the participants will have to give an undertaking as given in the respective tender forms authorizing RBI to act on behalf of them. Reserve Bank of India shall not, however be responsible for any loss, damage or liability on account of acting as the Custodian on behalf of the participants. A Repo Constituents' SGL Account (RC SGL Account) and Reverse Repo Constituents' SGL Account (RRC SGL Account) will be opened and held in the Securities Department in Mumbai Office for this purpose which will have institution-wise subsidiary records of the securities sold under Repo and securities bought under Reverse Repo. RBI will have Subsidiary Accounts in the case of both of these Accounts.

3. On success in auction in respect of Repos, the tenderer's RC SGL Account will be credited with the required quantum of securities debiting Bank's subsidiary account/Investment Account. Likewise, the tenderer's Current Account will be debited for the resultant cash flows and credited to the Bank's Account. The transaction will be reversed in the second leg.

4. In the case of Reverse Repos, on acceptance of bid, the tenderer's SGL account/ RRC SGL Account will be debited with the required quantum of securities and credited to Bank's Investment Account/Subsidiary RRC SGL Account. Accordingly, the tenderer's Current Account will be credited with the Reverse Repo amount, debiting the Bank's account. The transactions will be reversed in the second leg.

5. Transactions between RBI and counter parties including operation of the RC SGL Account and RRC SGL Account would not require separate SGL forms as provision will be made in the application form for the purpose. Likewise, transfer of securities from/to RBI's Investment Account and Subsidiary Accounts in the Repo and Reverse Repo SGL account will not require signing of SGL transfer forms. However, transfer from tenderer's SGL Account to the RRC SGL Account will require completion of SGL form. In the case of Reverse Repos, tenderers will have the option to either use the RRC SGL Account route or getting their SGL Accounts debited for the purpose of transferring securities to RBI.

6. Pricing of all securities including Treasury Bills will be at face value for Repo/Reverse Repo operations by RBI. Accrued interest as on the date of transaction will be ignored for the purpose of pricing of securities. Coupon, if any, will be transferred to RBI in the case of Repos, and RBI will collect the coupon, if any, on the due date and credit the same to the party's Current Account in the case of Reverse Repos.

Eligibility

All Scheduled Commercial Banks (excluding Regional Rural Banks) and Primary Dealers (PDs) having Current Account and SGL Account with RBI, Mumbai will be eligible to participate in the Repo and Reverse Repo auctions.

Minimum bid size

To enable participation of small level operators in LAF and also to add further operational flexibility to the scheme, the minimum bid size for LAF is being reduced from the existing Rs.10 crore to Rs.5 crore and in multiples of Rs.5 crore thereafter.

Eligible Securities

Repos and Reverse Repos will be undertaken in all transferable Government of India dated Securities/Treasury Bills (except 14 days Treasury Bills).

Margin Requirement

A margin will be uniformly applied in respect of the above collateral securities comprising the Government of India dated securities/ Treasury bills. The amount of securities offered or tendered on acceptance of a bid for Rs.100 will be Rs.105 in terms of face value.

Settlement of Transactions

The settlement of transactions in the auction will take place on the same day.

SLR and Securities held in Repo SGL Account

Securities held by RBI on behalf of banks' Repo Constituents' SGL account and credit balance in the RRC SGL Account will be counted for SLR purpose and a certificate will be issued to banks by RBI on a fortnightly basis. As far as valuation etc. for SLR purpose is concerned, extant DBOD instructions will apply.

Terms and Conditions

Tender Forms for "Repo Auction" and "Reverse Repo Auction" along with terms and conditions are enclosed at Annexures I and II.(to the Scheme -Please refer website of RBI)

Information Dissemination

For a smooth transition to full-fledged operation of LAF, banks and PDs are being provided a back-stop facility at variable rate of interest, as a cushion over the normal liquidity facility at Bank Rate. Along with the auction results, the rate of interest applicable for the back-stop facility for the concerned day will also be announced for the benefit of the participants who wish to avail of such facility. Further, to facilitate better bidding by the participants, additional information on the aggregate cash balances of scheduled commercial banks maintained with RBI, during the fortnight, on a cumulative basis with a lag of two days as also weighted average cut-off yield will also be released as a part of the Press Release on money market operations.

The third stage envisages multiple auctions intra-day, which became feasible with the introduction of electronic transfers of funds and securities. Since February 15, 2002, the members of Negotiated Dealing System (NDS) submit LAF bids on electronic platform instead of physical form.