Marginal standing facility is a window that allows scheduled commercial banks to borrow overnight from the central bank a maximum amount of 1% of total time and demand liabilities. Also, banks can avail finance against excess statutory liquidity ratio (SLR). Banks tend to borrow from RBI at MSF rates when there is severe asset-liability mismatch or cash crunch in the inter-bank market.
The borrowing under MSF facility requires banks to adhere to certain margin requirements depending on the collateral against which banks are availing finance. For instance, in case banks are borrowing funds from RBI keeping government of India backed securities as collateral they need to pay a margin of 5%. Else if the banks are borrowing with state development loans as collateral they need to fulfill 10% margin requirement.
The facility can be availed by different commercial banks for a minimum amount of Rs. 1 crore and in multiples of 1 crore thereafter. For the MSF, interest rate was fixed at 100 basis points( 1 basis point is one-hundreth of a percentage point) above the repo rate, which is the rate at which commercial banks borrow from RBI. So, under tight liquidity conditions bank borrow from RBI at a rate higher than the repo rate as per the liquidity adjustment faciltiy or LAF.
With two components namely repo and reverse repo, LAF enables banks to keep their daily liquidity differences in check. In a scenaro, when banks are short of funds they borrow from RBI at repo rate and otherwise they park the surplus with RBI earning interest on it.
MSF rate lowered in the recent monetary policy review
Marginal Standing Facility rate was increased in July to 10.25% to circumvent any speculative activity in rupee for purchasing dollar and as a liquidity tightening measure. However, as stated RBI slashed it by 75 basis points to 9.5% witnessing comparable stability in rupee dollar