Liquidity Management Framework (LMF)

What is LMF?
The LMF is the toolkit used by the Reserve Bank of India (RBI) to manage liquidity (cash) in the banking system. Its main goals are to control short-term interest rates and ensure smooth transmission of monetary policy.

Core Mechanism:

• LMF primarily relies on the Liquidity Adjustment Facility (LAF), which includes repo and reverse repo operations.

• RBI injects liquidity by lending money (repo) or absorbs excess liquidity by borrowing money (reverse repo).

• It operates under a “corridor system”, where the policy repo rate is the central reference rate.

• The key operating target of the LMF is the overnight Weighted Average Call Rate (WACR) — the average rate banks charge each other for overnight funds.

Other Tools under LMF:

• Open Market Operations (OMO): Buying/selling government securities for longer-term liquidity adjustments.

• Cash Reserve Ratio (CRR): Minimum reserves banks must keep with RBI to manage liquidity.

• Statutory Liquidity Ratio (SLR): Minimum liquid assets banks must maintain.

Recommendations by RBI’s Internal Working Group (IWG) on LMF

Key Terms Related to LMF

• Weighted Average Call Rate (WACR):
  Average overnight interbank lending rate weighted by transaction volume; RBI’s main monetary policy operating target.

• Variable Rate Repo (VRR):
  Auction-based repo operation where the interest rate varies based on market demand, unlike fixed repo rates.

• Variable Rate Reverse Repo (VRRR):
  Auction-based reverse repo operation to absorb excess liquidity; banks bid at variable interest rates to deposit funds with RBI.