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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to the Indian Financial Markets

Which statement about the Reserve Bank of India's Liquidity Adjustment Facility (LAF) is correct?

In a repo under the LAF, banks borrow money from the RBI by pledging government securities, which injects liquidity. In a reverse repo, banks place surplus funds with the RBI, which absorbs liquidity from the system.

  1. AUnder the repo, the RBI borrows from banks against government securities, and under the reverse repo it lends to banks
  2. BUnder the repo, banks borrow from the RBI against government securities, and under the reverse repo banks park surplus funds with the RBICorrect
  3. CBoth repo and reverse repo involve only the outright permanent sale of securities
  4. DRepo is used only to absorb liquidity, and reverse repo only to inject liquidity

Explanation

In a repo, banks sell securities to the RBI with an agreement to repurchase, thereby borrowing funds and injecting liquidity. In a reverse repo, banks lend surplus funds to the RBI and receive securities, which absorbs liquidity. The roles in the other options are reversed or the transactions are misdescribed.

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