Definition: The Marginal Standing Facility (MSF) is the rate at which the scheduled commercial banks borrow funds fortnight from the Reserve Bank of India against the government approved securities.
Now the question arises, why to use the marginal standing facility when banks can borrow funds through a Repo Rate? The need for MSF arises, to meet the short-term emergency needs of the banks in case of a severe cash shortage or when the inter-bank liquidity dries up completely and to curb the volatility in the overnight interest rates.
What is Volatility? Volatility refers to the variability of returns from the investments. It is directly proportional to the risk Viz. The higher the volatility, the higher is the risk of not getting the desired returns from the investments because of the fall in the market price, at the time it is to be en-cashed. Thus, to restrain from such volatility, RBI offered commercial banks the service to pledge their government securities and get more funds at a rate higher than the repo rate.
In the case of borrowings, the commercial banks can borrow funds overnight up to a certain percentage of their net demand and time liabilities (NDTL). What is NDTL? The NDTL represents the aggregate bank’s deposits along with the borrowings from others. The funds can be raised against all the government approved securities, including SLR (Statutory Liquidity Reserves- a reserve maintained by the commercial banks in the form of cash, gold, and other approved government securities – Bonds).
RBI uses Marginal standing facility to control and manage the money supply in the financial system. With the increase in the rate, the borrowing becomes expensive for the commercial banks and in return the loans become dearer for the individual or corporate borrowers, which will result in less flow of money in the market. Also, the MSF rate is often increased by RBI to curb the excessive availability of rupee and to avoid further rupee depreciation against a dollar.